Running your own business gives you a little more freedom in the way you pay yourself. This flexibility allows you to take advantage of various tax rules to draw your profits in the most efficient way possible.
Generally, your options for drawing an income from your business fall into three categories: salary, dividends, and pension contributions. In this article, we’ll be looking at the benefits of pensions for business owners and increasing your pension contributions.
Before we begin, it’s important to note that tax rules are complex, can change, and depend on individual circumstances. Always seek professional advice before making any decisions.
Making personal pension contributions
One of the best ways to extract profits from your business tax-efficiently is by making personal pension contributions to your pension pot.
– Annual Allowance
Each year you can contribute a certain amount completely tax-free to your pension fund, this is known as the pension annual allowance.
You’ll receive tax relief on your contributions, ranging from 20% to 45%, depending on your income tax rate. Starting from the tax year 2023/24, the government increased this allowance to £60,000, up from the previous amount of £40,000 per year.
If you haven’t used all of your pension contribution allowance over the last three years, you can carry forward any unused annual allowance from those years, allowing you to contribute a total of up to £120,000 plus £60,000 from the current tax year, completely tax-free.
However, if you take both salary and dividends as income, you should know that dividends don’t count as ‘relevant UK earnings’. Only the salary portion is used to calculate your pension tax relief limit.
The pension annual allowance is the lower of £60,000 and your relevant UK earnings during the tax year in question. This means that if you are taking a small salary and a large dividend from your company, your pension tax relief limit could be less than £60,000, and exceeding this limit will result in additional tax charges.
To increase the amount you’re allowed to contribute to your pension while still enjoying tax relief, you have two options: increase your salary or make the pension contribution directly from your company as an employer contribution.
– Lifetime Allowance
If you previously stopped contributing to your pension because you were nearing the lifetime pension allowance of £1,073,100, it might be time to reconsider. The previous government removed the lifetime allowance limit, and given it’s unlikely to be reintroduced by Labour, you can contribute without any limitations and without facing a tax penalty.
– Tapered Allowance
It is important to remember that if your personal income exceeds £260,000 per year (including salary, dividends, other income sources, and pension contributions from your company), your annual tax-free pension allowance will be reduced. For every £2 you earn over £260,000, your annual allowance decreases by £1. Once your income reaches £360,000 or more, your tax-free annual allowance is capped at £10,000.
Making employer pension contributions
Your limited company can contribute pre-tax income to your pension, which counts as an allowable business expense. This means your company can receive tax relief against corporation tax, potentially saving up to 25%.
Unlike personal contributions, there’s no cap on the company’s contribution to receive tax relief, provided it meets HMRC’s ‘wholly and exclusively’ test. This test is to make sure the contributions are made for business purposes. HMRC may look for evidence, such as whether other employees receive comparable remuneration packages.
However, the employer contributions do count towards your personal tax-relief annual allowance, which is £60,000 or up to 100% of your yearly income. This is the maximum amount you can contribute to receive tax relief. Additionally, you may be able to use the ‘carry forward’ rule if you have unused allowance from the previous three years.
Another benefit is that employers do not have to pay National Insurance on pension contributions. For 2024/25, the National Insurance rate is 13.8%. Contributing directly to your pension rather than paying the equivalent amount as salary means your company saves this money.
In total, your company can save up to 38.8% by paying money directly into your pension rather than as salary. Depending on your circumstances, this could be more beneficial than making personal pension contributions.
Amber River Financial Planning
Pension tax rules can be intricate and ever-changing, making it challenging to ensure you’re making the most of your contributions without incurring unnecessary penalties. This is why seeking professional advice is crucial.
At Amber River, our expert financial planners understand the complexities of pension planning and tax regulations. We provide tailored advice to help you optimise your pension contributions and maximise both your personal and business tax relief.
Get in touch
Amber River has a network of Chartered financial planners right across the UK, ready to offer truly independent advice. If you want to set up an initial appointment, call 0800 915 0000, or alternatively use our contact form here.
Disclaimer:
The information within this article was correct at the time of publishing, but laws and tax rules are subject to change. Your circumstances and where you live in the UK also have an impact on tax treatment.
