Tax efficient remuneration using pension contributions
In the lead-up to the 2018 Autumn Budget there was plenty of speculation that the Chancellor would take the opportunity to cut tax relief on pension contributions, which currently costs the Government around £38 billion a year. In the event, this was not to be the case, and the generous tax relief provisions continue to apply in their current form for the foreseeable future.
Subject to certain conditions, tax relief is currently available on pension contributions at the highest rate of income tax paid, meaning that English basic rate taxpayers get relief on contributions at 20%, higher rate taxpayers at 40%, and additional rate taxpayers at 45%.
In Scotland, income tax is banded differently, and pension tax relief is applied in a slightly different way.
Pensions are a particularly tax-efficient form of savings since nearly everyone is entitled to receive relief on contributions up to an annual maximum regardless of whether they pay tax or not. The maximum amount on which a non-taxpayer can currently receive basic rate tax relief is £3,600. So an individual can pay in £2,880 a year, but £3,600 will be the amount actually invested by the pension provider.
The total amount of tax relief available on pension contributions is calculated with reference to ‘relevant UK earnings’. If you own a limited company and you take both salary and dividends, the dividends do not count as ‘relevant UK earnings’. This means that if you take a small salary and a large dividend from your company, your pension tax relief limit will be low – tax charges will apply if the limit is exceeded.
If you want to increase your tax-free contributions limit, you could consider either increasing the amount of salary you take from the company (to increase your relevant UK earnings), or making the pension contribution directly from your company as an employer contribution. Making an employer contribution has additional advantages.
Qualifying employer contributions count as allowable business expenses, so the company could currently save up to 19% in corporation tax. In order to qualify for a deduction, the pension contributions should be ‘wholly and exclusively’ for the purposes of business. HMRC will check for evidence that this is the case, for example whether other employees are receiving comparable remuneration packages.
Another advantage of making a company contribution is that employer National Insurance Contributions will not be payable, saving the company up to 13.8% on the contribution amount.
This means that the company can potentially save up to 32.8% by paying money directly into your pension rather than paying money in the form of a salary. Depending on your circumstances, this may or may not be more beneficial to you than paying personal pension contributions.
Benefits for employees
An employer-provided pension can be a significant benefit. Employers can make contributions to occupational or personal pension plans without triggering a tax charge. This can significantly enhance an employee’s remuneration package and is a tax efficient way of rewarding employees. It is also worth noting that, subject to a couple of conditions, a relatively new tax exemption may cover the first £500 worth of pension advice paid for by an employer. The exemption covers advice not only for pensions but also on the general financial and tax issues relating to pensions.
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