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Pension contributions are one of the few remaining tax breaks available to limited companies. It makes sense to take advantage of this tax break for you, as a company director, and your employees if you have any.
By law, you already need to contribute certain amounts into your employee’s pension fund as part of the government’s auto-enrolment arrangements. However, there are good reasons why you might want to contribute more than the minimum amount.
Paying pension contributions is tax-efficient because you’ll reduce your company’s taxable profits and therefore your Corporation Tax liability. Making the contribution through your limited company is usually more tax-efficient than making the contribution from your own funds.
Because of the complex nature of pension schemes, we strongly recommend you take specialist advice from an independent financial advisor before making any contributions into an employee pension scheme (including your own).
Our Crunch accountants cannot provide such advice, but we have an Investments and Pensions service which can refer you to Hargreaves Lansdown, who can help you with this type of specialised financial advice – and even offer a free consultation.
For the 2020/21 and the 2019/20 tax years, the Corporation Tax rate is 19%. So for every £100 your company earns as profit, you’ll pay Corporation Tax of £19, reducing the amount you can take from your company as a dividend to £81.
Paying £100 into an employee’s pension fund effectively costs the company only £81 due to the reduction in Corporation Tax payable and, over time, the £100 investment can hopefully grow within the pension fund.
Generally, you can start withdrawing from your pension fund at the age of 55. This can be used to help you retire early or to top up your income if you are still working. Again, you should take specialist advice on this, particularly if you plan to keep working while drawing a pension.
You can pay as much into your employee’s pension scheme as you like, subject to HMRC’s contribution limits and rules.
Your contributions will be tax-free as long as they do not exceed the annual allowance, which is currently capped at £40,000 (2020/21 Tax Year). The amount that you pay must not exceed your company’s income for the year as this could raise questions from HM Revenue and Customs as to whether the amount has actually come from your company’s trading.
If you have a large amount that you would like to put into your employee pension scheme, then you may be able to take advantage of the carry forward rule. This allows you to make use of annual allowances that have not been used in the previous three years, provided that the employee was a member of a registered pension scheme. If you would like to carry forward, you must first use your full annual allowance for the current tax year before using any unused allowances from the previous three years.
You should also take into account your lifetime allowance, which is a limit on the amount that can be withdrawn from your pension scheme through either lump sums, or through retirement income, without incurring extra tax. The lifetime allowance is currently £1,073,000 in 2020/21 (increasing from £1,055,000 for 2019/20 Tax year).
As stated earlier, you should take advice from a pensions expert, who’ll be able to properly advise you on your situation. Crunch has partnered with Hargreaves Lansdown who offer a range of financial services including individual financial advice.