Pension Contributions vs Salary or Dividend
If we assume that you are an additional rate taxpayer, you will pay 50-55% in tax when you take money out of your business as salary or a dividend. You will pay 33.75% in tax if you take it via your pension.
This is largely because pension contributions made from your company are treated as an expense and so are not subject to corporation tax. It’s also because the first 25% of withdrawals from your pension is tax-free.
So What’s The Catch?
Well, you can’t (or probably shouldn’t) access the funds within your pension immediately; you must wait until you are of pensionable age and, even then, you’re likely to want to withdraw the money gradually. So this is no good if you need the money to pay school fees right now. But it’s real good if this is profit that is in excess of your ongoing needs.
But Shouldn’t I Wait Until I Sell The Business?
Maybe, but quite possibly not. If you are going to sell the business very soon and you will benefit from Entrepreneurs Relief then your tax rate may be marginally lower. This is because you will still pay corporation tax on the profit, so your tax hit is the 10% capital gain plus 19-25% corporation tax.
However, Entrepreneurs Relief is now limited to only the first £1 million of capital gain. For any gain above £1 million then a pension contribution remains the most tax efficient means of profit extraction (again, assuming you are an additional rate taxpayer).
And finally… unless you are going to sell the business very soon, the corporation tax is payable immediately and any future income or gains the company makes on the profit, e.g. bank interest, will also be subject to corporation tax. In contrast, the profit that goes into your pension does not incur corporation tax and any gains and income are free of tax (until withdrawal).
So, really, there are only limited circumstances where it’s preferable to keep cash in the business rather than putting into a pension.
But Shouldn’t I Re-invest In My Business?
Well, this one's for you to answer. Perhaps you should. If you’ve made it this far, you’ve probably shown that you’re capable of generating a return on capital well in excess of what TindleWealth or any other manager could get you in shares and bonds. But, depending on the stage of your business and your life, you also probably know that stowing away some profits along the way is sensible, and that is where these generous pension contribution allowances become highly relevant.
Ok, I get it and I like it. How much can I put into my pension?
£60,000 in the current tax year or up to £180,000 if you have not contributed to a pension in the previous three tax years. Does your spouse work for the business as well? Then (likely) double the amounts above. So that’s up to £360,000 of profit on which you can save corporation tax and invest tax efficiently for the long-term. Oh… and, under current rules, it’s also free of inheritance tax.
The rules regarding pension contributions are somewhat complicated. The above is intended as a simplified explanation of what is possible and should in no way be taken as advice specific to your situation. You should consult with a regulated financial adviser, such as TindleWealth, if you are considering making pension contributions from your limited company.
Get in touch to discuss this in further detail. All initial consultations are free of charge.