Tax efficient pension contributions for company directors
Posted on 19th June 2023
Pension contributions are a tax-efficient option if you’re a Director of a limited company. You can save for your retirement using profits from your business, which is an allowable expense.
It's possible to claim tax relief on pension contributions for yourself and as an employer to reduce your Corporation Tax bill as well.
Your business can contribute to your pension from its profits providing it meets HMRC’s test of being ‘wholly and exclusively’ for the purposes of business. Employer contributions aren’t limited to your UK earnings. However, they do count towards your annual tax free pension contribution allowance, which is now £60,000.
Pension Lifetime Allowance
The tax free Lifetime Allowance (LTA) for most people is £1,073,100. Before the 2023/24 tax year you would pay a charge on pensions savings over this limit. However, new rules from 6 April 2023 mean you now pay income tax instead. You can still take a tax free lump sum from your pension pot when you start to draw your pension. If you have used your full LTA that’s £268,275.
Pension contribution ‘carry forward’
If you haven’t used your annual pension allowances for the previous three years the 'carry forward' rule might apply. To use this option, you must be part of a registered pension scheme.
If you paid £30,000 pension contributions in 2020/21, 2021/22 and 2022/23 you didn’t use your full £40,000 allowance. If the ‘carry forward’ rule applies you could contribute £30,000 in addition to your £60,000 tax free allowance for 2023/24
Reducing tax with company pension contributions
As a company director you can receive tax relief on pension contributions from your salary up to £60,000 or 100% of your PAYE income. Depending on how much you earn, you'll receive tax relief at the highest rate you pay; 20%, 40% or 45%.
For example, as a basic rate taxpayer with income between £12,571 to £50,270 you’ll pay 20% tax. You’ll only pay £80 for every £100 that goes in to your pension and the government will add £20.
As a higher rate taxpayer earning between £50,271 to £125,140, your £100 contribution costs £60 with £40 tax relief. As an additional rate taxpayer, you’ll pay £55 of your £100 contribution and receive £45 tax relief.
Corporation Tax rates have now changed to a scale between 19% and 25% depending on your company profits. This makes working out the benefit of making pension contributions a little more complicated.
For example, if your company profit is £100,000 your effective Corporation Tax (ECT) rate is 22.75% so you’ll pay £22,750. You can make additional tax free employer pension contribution of £10,000. This would reduce your company profits to £90,000 and the Corporation Tax you pay would go down by £2,275.
Your company doesn’t pay National Insurance on pension contributions either, so this saves a further 13.8%.
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