Pension Contributions if you are a Director of a Limited Company
If you work through a limited company, it can be very tax efficient to have your limited company make pension contributions directly into your pension scheme. Please note that we are not pension advisors so we cannot give specific pension and investment advice and if you are interested in starting a pension, we would strongly advise that you discuss your specific circumstances with a pension advisor.
To start with I need to explain the difference between pension contributions made personally and contributions made by your company (aka employer contributions).
As a limited company owner, you should make sure you are a director of your company to justify the company pension contributions.
Contributions made by your company are paid directly from your company bank account into your pension scheme (just check with your pension provider that they can take company contributions) The pension provider must be told that these contributions are ‘employer’ contributions, this will ensure they are treated correctly for tax in the pension fund – unlike personal contributions, they will not be ‘grossed up’, which means that if £100 is paid by your company, £100 is what goes into your pension, there is no additional tax credited like there is usually with personal contributions.
Contributions made personally are from your own pocket and when paid into your pension fund are normally grossed up by 20%. For example, if you pay £80 into your pension fund, £20 of tax credit is added by the government and your total pension addition is seen to be £100.
Typically, with personal contributions if you are a basic rate taxpayer you get no additional benefit through your personal tax return, you just get the 20% tax added into your pension fund, but if you are a higher rate taxpayer you save an additional effective 20% tax through your personal tax return (depending on how far you are into the higher tax band compared to the total gross pension contributions made).
Just remember that personal pension contributions are made from your own pocket so you will have potentially paid income tax on your salary/dividends already, which differs to company contributions as they are paid directly into your pension.
Personal pension contributions will also usually have a lower annual limit than company contributions. This is because with personal contributions you are limited to your total gross pension contributions not exceeding your earnings, and your earnings include your salary from your company but do not include your dividends, therefore for a typical limited company director their earnings for 21-22 may only be the £735 per month salary, which is £8,820 for the year.
Company contributions don’t have this limit, although they do have other limits which we’ll discuss below.
We are focussing on your limited companies pension contributions as they tend to be the most effective structure for limited company directors.
When a company makes employer pension contributions into a pension fund, the company is allowed to treat these contributions as a business expense just like with a director’s salary, so the company saves corporation tax (19%) on the cost.
A benefit with this compared to personal contributions is that you are getting tax savings up front rather than in your pension fund which you can’t access until later in your life.
One thing to be aware of is that HMRC will only allow the corporation tax savings if your salary, any benefits-in-kind, and pension combined are not seen to be ‘excessive’ for the role you are performing in the business. There was a First-tier Tribunal (FTT) case where directors used their personal pension funds to decrease the companies’ profits to 0 i.e., contribute all the profits into the pension scheme.
For a business owner/director working full time it would usually only be if you are making excessively large company contributions that you would start to get into dangerous territory and risk a HMRC challenge.
Things to consider when assessing if your contributions are excessive:
How much would you have to pay someone to do your role
What is your level of experience and how senior is your role?
How many hours do you work i.e., how full time is your role?
Is the company making sufficient profits to support the level of contributions?
Company pension contribution limits
There are some limits to be aware of with company pension contributions.
The total maximum gross pension contributions (company and personal) per person is £40,000 per year for the 21/22 tax year.
If your ‘adjusted income’ is above £240,000 (21/22 tax year) then there are rules that reduce this £40,000 annual allowance – typically ‘adjusted income’ is your total taxable income plus any employer pension contributions.
Also, you may potentially have un-used allowances from previous years you can bring forward to increase this limit (check with your pension advisor).
Your annual allowance might also be lower if you have flexibly accessed your pension pot.
There is also a lifetime limit which for most people is currently set at £1,073,100 for the 21/22 tax year, if this is breached it will cause certain tax issues.
Wrapping that up:
For limited company owners/directors who have profits in their business and are already maximising the basic tax band, company pension contributions can be a tax efficient way to save for their retirement. You must also bear in mind that you won’t be able to access your pension fund until later in life.
Generally, overall, there is not a lot of difference between the tax savings of personal contributions compared to company contributions, however for limited company directors, employer pension contributions are often more suitable because:
company contributions are typically allowed to be higher than personal contributions as your total contributions are not limited to your salary.
you get corporate tax rate (19%) of the tax relief up front with the corporation tax savings, rather than in your pension fund.
they don’t affect your personal tax return and salary / dividend planning so tend to be a bit simpler to understand
Finally, please bear in mind that making company pension contributions is using company cash resources so it will mean there are less profits available for dividends.