Employee vs Employer Contributions: The Smart Way to Maximise Tax Efficiency
Business owners are strapped for time. Whether a sole trader or a CEO of an SME, any and every business owner knows more than most the concept of being time poor.
Beyond the obvious impact that having a heavy workload has on day-to-day life, one of the main issues of being strapped for time is that a lot of low-hanging fruit with regards to their finances is often ignored.
In fact, as financial advisers, we often find that a lot of our clients are either fully aware of what they can do to be more tax-efficient and simply don’t have the time, or they haven’t had the time to properly research it at all.
So it’s no surprise then that one of the questions we’re most often asked from busy workers and high-earners is how they can contribute to a personal pension as tax-efficiently as possible. Whilst this is usually a question for accountants, today we’ll look at some of the benefits of making contributions through a limited company.
The state of play
Many small businesses are owner managed limited companies where they have been advised by their accountant to have their business affairs conducted through a limited company as it can be more tax-efficient.
Understandably, business owners, directors, or higher or additional tax rate payers are among those most often attracted by the potential tax relief of 40 or 45% that these contributions may have if they are made personally and not through their limited company. If made personally, any tax relief over the basic rate would need to be reclaimed via their tax return.
However, we must first look at how much it costs for the majority of business owners to obtain this money from their company to make these pension contributions.
There are two main ways that business owners pay themselves from their limited company:
- Through a salary
- Through company dividends
The decision of which to make would normally be decided by the business owner and accountant and is often a combination of both salary and dividends.
What happens if I’m paid through a salary vs company dividend?
If a business owner is paid through a salary, the company could pay up to 15% in employer National Insurance contributions and the employee (the business owner) up to 10% in employee national insurance contributions, plus an additional income tax of up to 45%; this would mean a combined payment of both the limited company and payee of up to 70%.
Dividend payments on the other hand are normally paid after the payment of corporation tax of up to 25%, plus the tax due on the dividends. Higher rate taxpayers could pay up to 35.75% and additional rate taxpayers 39.35%, making a possible maximum total payment by both the company and individual of up to 64.35%
In addition, when making personal contributions payments in excess of £3,600 (gross), tax relief is limited to the amount of relevant earnings, which dividend payments do not count as being part of.
However, if pension payments are made as pension contributions through the company -provided they are "wholly and exclusively " for business purposes - payments are not restricted to relevant earnings but are subject to the annual allowance but if applicable subject to certain conditions clients can use the previous three years’ allowance potentially making contributions of up to £240,000.
Pension contributions can, subject to certain conditions, be treated as a business expense, which means company profits are calculated after these payments are deducted thereby potentially reducing the amount of corporation tax payable by the company. In addition, no national insurance is normally payable by the company or individual on these contributions and no income tax on the company pension contributions by either the company or the individual which can lead to extracting money from the limited company in a tax advantageous manner.
It is recommended for the business owner to be advised by the company accountant on the best way to make pension contributions and, if it is to be made through the company, the amount and frequency of these payments. It is also recommended that the financial adviser (often working in tandem with the accountant) conduct a full financial fact find to determine the client's risk level and the most suitable pension product available for the individual.
Explore your options with expert advice
If any of the above sounds like you, and you’d like to know how to make the most of the opportunities available to you, then please reach out to us at gwwealth@sjpp.co.uk. Both of our qualified financial advisers, Tom and Vishal, offer a no obligation 30 to 60-minute initial consultation to go over all of your financial arrangements and see how we can best service you; if it turns out that you’re already as tax-efficient as can be, or if you choose to go in another direction for any reason, then you don’t pay a penny.
All we ask for is, well, a little bit of your time.
The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and the value may therefore fall as well as rise. You may get back less than you invested.
The levels and bases of taxation and reliefs from taxation can change at any time. Tax relief is dependent on individual circumstances.
Although the content of the article was correct at the time of writing, the accuracy of the information should not be relied upon, as it may have been subject to subsequent tax, legislative or event changes.
