Limited company owners are in a unique position when it comes to retirement planning. Not only can you potentially access special investment vehicles (such as a Small Self-Administered Schemes), but you could also boost the value of your pension while saving tax via employer pension contributions. In this guide, our financial planners at Vesta Wealth here in Carlisle show how company owners and directors can extract business profits in a tax-efficient manner.
When most business owners think about taking money out of their business, the first thought is usually to pay themselves a dividend. It is true this is generally more tax-efficient than paying it as income. But paying yourself in this way still gives rise to corporation and income tax. Instead, you might want to consider making employer contributions into your personal pension.
Employer contributions and tax
Under UK auto enrolment rules, in 2022-23 an employee must contribute at least 5% of their salary into their workplace pension. The employer, moreover, must put in at least 3%. The latter is treated as a business expense by HMRC and deducted from profits before being assessed for corporation tax. With some careful planning, therefore, making further employer contributions into your pension could help to reduce your corporation tax bill, whilst also boosting your future retirement fund.
No income tax is due on the contribution (unlike a company bonus or dividend). Moreover, the funds will grow tax-free within your pension, raising its growth potential through compound interest. In fact, if you are a company owner and want to boost your retirement fund, then increasing company contributions is often more tax-efficient than using your own money.
Employer contribution case study
Imagine you want to withdraw £10,000 from your business. As the tax year ends, you see that your company has £10,000 that could be used. If you took this as a dividend, then you could take £8,100 after 19% corporation tax on the profit is subtracted.
However, the taxes don’t stop there. As a Higher Rate taxpayer, you pay 33.75% tax on this dividend (assuming that your £2,000 yearly tax-free allowance has been used). This leaves £5,366.25 after a further £2,733.75 is taken away in tax.
As such, to take £10,000 as a profit from your business, you only receive £5,366.25. This is the same as getting taxed at 46.3%.
However, suppose you didn’t take the £10,000 as a dividend – but made an employer pension contribution instead. Here, you get the full amount and save £5,366.25 in tax. There is no corporation tax to be paid and no income tax either.
Some rules to consider
Technically, there is no “upper limit” on how much your company can put into your pension. However, you should seek financial advice to make sure your employer contributions do not raise questions with HMRC. In general, it is a good idea to keep these within your company’s income for the tax year.
Remember, there is an annual allowance of £40,000 on your pension contributions (or, up to 100% of your income if this is lower). Yet certain pension rules (e.g. the “taper” or triggering the MPAA rules) may lower this for specific individuals. A financial adviser can help you work out how much you can contribute without incurring a tax charge.
Another thing to bear in mind is “carry forward”. In 2022-23, you are allowed to access unused pension annual allowance from the previous three tax years. Technically, this could allow up to £160,000 to be paid into a pension in a given year. Here, you need to have been a member of a registered pension scheme during this whole period.
Other tax-efficient options
Whilst employer contributions can be a very tax-efficient way to extract profits, it is not always the most practical option. Putting money in your pension does restrict your access to it so this might not be suitable if you need the money now. Since corporation tax of 19% is applied on company profits, a good idea instead is simply to reduce the profits before they are assessed – i.e. by claiming every expense you can.
An accountant can help you determine the full range of expenses available to claim in your own situation. In many cases, you can also claim “dual purpose” expenses (where the expenditure was for both professional and personal use). Whatever you do, make sure you keep accurate and clear records so you can show the evidence to HMRC.
Bear in mind that the UK’s corporation tax rate is set to rise to 25% from 1st April 2023 on profits over £50,000. So, consider getting the most from your profits now, before this window closes.
Final thoughts
Of course, saving on tax is not the only financial goal your business is likely to have. Keeping a high degree of financial stability and protection will also be important considerations. To a high degree, this rests on your business model.
However, much of it also depends on having a good business financial plan to help you weather possible future storms. Key person protection, for example, can grant a lump sum to cover the loss of a key employee.
Financial planning can also help you with staff retention and productivity. Offering your team a strong employee benefits package (e.g. “death in service” benefits”) can help incentivise your best people to stay around and give their best to the company.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.