It is the time of year when we start to look at tax planning one of the few tax breaks still open to limited companies that will save corporation tax is to make contributions to a pension scheme.
How does this work?
If you're a Director of a limited company you can contribute pre-taxed company income to your pension pot and because an employer contribution counts as an allowable business expense, the payment will increase your overheads and therefore reduce your profit and with it the amount of corporation tax you will have to pay.
As a company director of your own limited company, you can contribute to your director's pension through your limited company as well as personally and it’s possible to claim pension tax relief on both. However, contributing through your limited company is usually more tax-efficient than contributing your funds as an individual, due to the savings that will be made to the corporation tax bill.
How much can my company contribute to my pension as a company director?
Employer contributions count towards your annual allowance, which is currently set at £60,000, this is the maximum you can pay into a pension in one tax year and still receive tax relief. It is really important to remember that the allowance is combined across all your pensions so if you have more than one you will have to split this allowance between the different pensions.
If you have a large amount you'd like to contribute, you may be able to benefit from the 'carry forward' rule, this enables you to use any allowance which hasn’t been used over the previous three years, the caveat here is that you must have been a part of a registered pension scheme during the time you are claiming the relief. So, if you didn’t use your total allowance over the last three tax years, you can use the leftover amount to boost your contributions this year. If you do go over your allowance the excess contributions will be added to your gross income for that year and will be taxed.
How much tax could I save by contributing to my pension via my limited company?
A company director can personally contribute £60,000 or 100% of your PAYE income and still get tax relief. The relief you receive will depend on your earnings and you’ll receive tax relief at your highest marginal rate, either 20%, 40% or 45%.
If you’re a 40% rate taxpayer for example, you will automatically receive relief at 20% but will have to complete a self-assessment tax return to claim the remaining 20%. Therefore, a contribution of £500 will only cost you £300 because the government will add £200, made up of £100 added immediately and £100 you'll have to reclaim later via your tax return.
There is another advantage to the employer of paying a salary in the form of pension contributions and that is the savings made on Employers National Insurance. Payments to a pension scheme do not attract Employers NI and with the rate for 2023/24 set at 13.8% this can offer another considerable saving.
In summary your company could save a considerable amount of tax by paying money directly into your pension rather than paying it in the form of salary, however there are some things to consider:
You can make pension contributions from pre-taxed company income, contributions are classed as an allowable expense on the P&L and as such reduces the corporation tax liability.
Some things to consider as HMRC will be looking at the following before allowing contributions.
The pension contributions cannot be more than the companies annual profit. So if your company has a profit of £40,000 for example the maximum, pension contribution payable by the company would be £40,000 for that year.
If you employ staff ensure you're making similar contributions to other in the company whose work is of a similar value.
The employer pension contribution is wholly and exclusively for the employer's trade profession.
The total remuneration package that includes salary, dividends and pension contributions is commercially reasonable for the work being done. Where the company is a sole director business and the Director is the main generator of the business income it is extremely unlikely that this test will not be met.
Finally, because Pensions are a complex area I would highly recommend that you speak to a qualified Financial Adviser before making any decision about your pension.
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