Benefits of business over personal pension contributions
When working as a contractor, consultant or freelancer it’s often easy to forget about pensions but putting something away for later life is not only sensible but can be very tax-efficient. Many people we encounter miss a trick by making personal contributions rather than making them through their company or get put off by thinking that they have to contribute through auto-enrolment to put it through the business. In most cases, it requires very little effort, very little time and almost no ongoing admin.
When dealing with pensions, it’s always advisable to sit down with an IFA to discuss your options before making any decisions. A small issue with your pension now could cost £000’s by the time you retire so it’s best to get a professional opinion.
Why contribute through the business?
Making personal pension contributions is great and can be tax-efficient but if you’re the director of your own company, you could be missing out on considerable tax savings. The example below shows the difference between a basic rate taxpayer contributing £100 that their limited company has earned, personally and through the business:
Personal contribution – The business would first pay 19% corporation tax on the £100. Then the individual would need to pay themselves the remainder as a dividend leaving them with just under £75 to contribute into a pension after the dividend tax. The pension provider would then ‘gross-up’ the contribution to £93.66 (£91.13 for a higher rate tax payer).
Business contribution – The business simply contributes the £100 and as it’s tax-deductible, the business pays no corporation tax and you pay no personal tax. As no tax has been paid, there’s no tax relief when it gets to the pension pot but you’ve still made a saving of around 6.5% (8.9% for a higher rate tax payer)
This could potentially save over £2k per year (or over £3k for a higher rate tax payer).
How much to contribute?
There’s no simple answer to this question and it’s always best to consult an IFA before making decisions on your pension but there are limits that will always apply:
· If you make a personal contribution, you can’t contribute more than you earn and still get the tax relief. So if you take a £20k salary you couldn’t get full tax relief on a £30k pension contribution unless it was a business contribution.
· There is an annual cap on how much tax relief you can get per year and in 2019/20, it’s £40k (£3,333.33 per month). You can contribute more than this but there will be no tax benefit of doing so. You can carry forward unused amounts of this £40k allowance up to 3 years to potentially get more than £40k of tax relief but you must have had the pension scheme in place to enable you to carry forward the allowance (so you can’t use last year’s allowance if you’ve only just set up a pension scheme).
· As well as the annual cap, there’s a lifetime cap and in 2019/20 it’s £1.055m. You can contribute more but this will incur a tax charge.
How to make contributions into a pension?
A good IFA will guide you through the following steps and do the majority of the work for you but you basically need to:
· Decide which type of pension you’d like;
· Decide on a provider for your chosen pension type;
· Set up the pension scheme;
· Decide how much you’d like to contribute;
· Start making contributions.
After this you can just sit back while your pension pot grows but providing you’re not contributing the maximum amount, it might be a good idea to chat with your accountant and IFA about a potential lump sum near the end of the tax year.
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