Why businesses should consider pension contributions as a tax efficient option
No one likes to pay more tax than they have to and with our expertise and careful tax planning, we can ensure that our clients fully utilise and maximise the tax reliefs, allowances and exemptions that are available to them. This will help you not only to avoid falling foul of HMRC, but also be safe in the knowledge that your money is working as tax efficiently as possible.
In this article we will look at the tax efficient option of employer pension contributions.
What options do you have when it comes to your business profit?
There are three ways owners of SME companies could take their profits; as a salary, dividends or pension contributions. While dividends may still be king, changes in how they are taxed may drive more directors to extract profits using employer pension contributions instead.
Let’s have a look at the net benefit derived from £40,000 of gross profits to a higher rate taxpaying shareholding director in the 2018/19 tax year:
Taking into account all relevant taxes (corporation tax, national insurance and income tax), the net benefit to the director would be as follows;
- Bonus option = £20,387
- Dividend option = £21,870
- Pension contribution option = £40,000
Clearly, the dividend route provides more spendable income than the bonus alternative. But if the director doesn’t need this income, the value in their pension pot is almost doubled!
Tapered Annual Allowance
If you are a high earning business owner, you could see your annual allowance (AA) tapered down to just £10,000. However, reducing what you take in salary or dividends and paying a larger employer pension contribution instead could mean you retain your full £40,000 AA. This is because contributions of this type will not be viewed as salary sacrifice, and therefore will not count towards your ‘threshold income’.
As the tax year draws to a close, here are several reasons you may benefit from making an employer pension contribution now:
- Avoid AA tapering – to ensure that this year’s annual allowance is not tapered. Remember bonus and dividends count towards the £110,000 threshold income, but employer contributions normally don’t.
- Use full pension allowance – to use up any unused annual allowance from 2015/16, which could be more than you think and would otherwise be lost.
- Deliver more tax efficient income – so that profits which may otherwise be taken as bonus or dividend don’t boost income to the point where the personal allowance is lost, or child benefit tax charge is applied.
- Create a tax efficient legacy – pensions typically don’t form part of the estate for IHT.
- Get in shape for retirement – to maximise tax efficient funding if you shortly plan to reduce working hours pre-retirement and start to draw pension income, at which point any future funding will be restricted to the money purchase annual allowance of £4,000 and unused carry forward allowances lost.
In addition to this, there will be many companies with a financial year in line with the tax year. These companies will not be able to confirm any final dividend until after this date. If these dividends are subsequently paid in 2019/20, they may use up next year’s dividend allowance before the new company year has even started.
Get in touch to find out more about our tax planning services
Springfield Financial Services Ltd offers tax planning services to individuals across Preston and Lancashire, as well as further afield.
For further information or to arrange an initial no-obligation consultation, please telephone us on 01772 729 742, or alternatively, simply fill out our online enquiry form and we will give you a call to discuss your requirements.