Additional Pension Contributions
It is often advisable to make additional pension contributions in order to maximise tax efficiency. In fact, it's one of the best ways to withdraw money from a company and I am often advising our clients to do so, especially close to the year end.
Here are the key things to be aware of:
- Most people have an annual allowance of £40k that can be put into their pension. However if you are a higher earner (>£200k per year) your allowance could be tapered and specialist advice may be needed before you proceed.
- If you haven't used up your annual allowance before it rolls forward for three years, so you can end up being able to contribute £160k in year 4! However you must have had a pension scheme open from year 1 in order to roll forward the allowance. So, the sooner you open a pension scheme (even if you don't contribute to it), the better.
- Many directors/founders have a remuneration strategy of low salary combined with dividends. However this means that you won't automatically register with your company's workplace pension scheme because the threshold is a salary of £10,000. A company's workplace pension scheme is often not suited to director/founders for this reason and it is often advisable to look at opening a separate pension scheme for the directors which makes it easier to pay in lump sums.
- There is actually very little admin/hassle involved in having a pension scheme (whether it is the company's workplace pension or a separate scheme for directors/founders). Once it is set up you simply make contributions (i.e. pay funds) into it, and that's it! The accounting is super simple, and if done correctly it doesn't even need to go onto your personal tax return, as it is tax free.
- For the highest level of tax efficiency you should ensure that you make employer contributions into the scheme, and not employee contributions. This means that your company is paying into the scheme, not you personally, and therefore the contributions are tax deductible for the company. Not all pension schemes allow for this, so you will want to check carefully before applying.
- If you usually claim R&D tax credits on your salary the company can include the cost of your pension in the R&D calculations, further increasing the tax efficiency of the pension contribution.
- Pension contributions cannot be accessed until you reach retirement age, and therefore if you have short term cash requirements (e.g. such as saving for a house purchase deposit etc.) you may not want to tie you money up for such a long time.
It is important for me to state that as chartered accountants (and not financial advisors) we are not allowed to provide pension advice, meaning we cannot advise you on which pension scheme (or underlying investments) to pick. You should also be aware that a pension is ultimately a financial investment and therefore its value can rise as well as fall over the years and you could end up with less than you put in. We are able to advise on the tax and accounting elements as done so in this article, but when it comes to advising which product to select, we must remain silent. We can point you in the direction of financial advisors and planners if you wish.
Tech Startup Ltd is due to make a profit of £40,000 in year 1. Prior to the end of the company's financial year the founder decides to make an employer contribution of £40,000 into his pension scheme:
- The company's profits are reduced to nil, saving corporation tax of £7,600.
- The £40,000 arrives in the founder's pension account free of income tax.
- The company claims R&D tax credits on the pension contributions, resulting in a cash rebate to the company of up to £11,800 (depending on the levels of R&D conducted by the founder).
Note that had the contribution been an employ ee contribution and not an employer contribution then the first and third bullet points above would not apply, thus an employee contribution is far less beneficial overall.
HMRC have a calculator here to help you work out your unused annual allowance.