Directors can make contributions to their pension schemes broadly in two ways:
- A Personal Contribution – up to a maximum of £32k per annum, which the pension scheme then grosses up to £40k by claiming back basic rate tax – bearing in mind that as a personal contribution this will be funded out of tax paid personal income, so this is not often an attractive option.
- A Company Contribution – of in theory up to £40k per annum, which should be an allowable expense for Corporation Tax purposes and funded out of the company’s pre tax profits.
For most company directors, the second option of a company contribution is the most effective and simple solution.
So, in reality how much can a company pay into a directors pension scheme?
In simple terms the maximum contribution per year is £40,000 each, but this is in theory capped at the level of your relevant earned income, ie including salary and benefits in kind, but not dividends. This is where an element of confusion comes in.
Many company directors, who hold shares in their companies will opt for a low salary, high dividend remuneration model
In reality this often means a circa £8k salary, with dividends targeted to keep them below relevant income tax thresholds. This is mainstream, non provocative tax planning and its benefit has been watered down in recent years with the new Dividend Tax.
So, where do directors with only an £8k salary stand with regards to company pension contributions?
Contributions made by a company must abide by the rules for allowable deductions for Corporarion Tax purposes. The rules state that the pension contributions should be ‘wholly and exclusively’ for the purposes of business and as an allowable business expense, the company receives tax relief against corporation tax on the full contribution, up to £40k.
Contributions by the company can be more than your relevant earned income, and HMRC’s view is that contributions to a registered pension scheme will normally be allowed and that it would be ‘relatively rare’ for a pension contribution not to be for the purpose of the employer’s trade
A contribution would not be allowable if there is an identifiable non-business purpose for the employer’s decision to make the pension contribution or for the size of the contribution.
Please check with us and with your Independent Financial Advisor before making any pension contributions, either personally or through your company.
Martin Gibbs is Dafferns Managing Partner and specialises in advising small and owner managed businesses – to contact Martin, please click here