Tax Relief on Pension Contributions

If you own a limited company, there’s never been a better time to optimise your pension strategy. Making pension contributions through your business in the form of employer contributions offers significant tax benefits that can supercharge your retirement savings.

Let’s dive into it…

The downside: 

While making pension contributions through your company offers significant advantages, it’s important to be aware of one key difference:

No Tax Relief Top-Up: Unlike personal contributions, employer contributions don’t receive the automatic 20% top-up from HMRC. This means if you’d normally contribute £80 personally and receive a £20 top-up, your company would need to contribute the full £100 to result in the same total being in your pension pot.

Now for the good bit:

Your company’s pension contributions are fully tax-deductible. This translates to significant savings on your Corporation Tax bill. The exact amount saved depends on your company’s yearend taxable profit level, but typically ranges between 19% and 26.5%.

For example: Let’s say your company faces the standard 25% Corporation Tax rate. By contributing £100 to your pension, your company would save £25 in taxes.

The bottom line: By making a £100 employer contribution to your pension, you not only boost your retirement savings but also gain an extra £5 advantage over making a personal contribution due to the tax savings for your company.

Higher rate taxpayers

If you’re a higher-rate taxpayer, pension contributions through your company become an even more powerful tool for tax optimisation.

For a limited company owner, personally paid contributions increase your Basic Rate tax band.  For a limited company owner this means that it increases the level of dividends that you can earn which are taxed at only 8.75%.  This is to compensate that the pension pot itself will receive just a 20% tax credit, Higher Rate tax-payers could however be paying 40% tax and therefore the uplift of the Basic Rate tax band attempts to even this out.

In contrast, company paid contributions don’t increase the individuals basic rate tax band, but they do result in Corporation Tax savings for the company at a potentially higher rate, which could outweigh the personal position.

Example:

Let’s say you contribute £10,000 to your pension personally.

Your Basic Rate tax band will increase by £12,500, allowing up to £12,500 of drawings from the business as dividends to be taxed at just 8.75% instead of the higher rate of 33.75%.  While £10,000 of this is used for the pension contribution, it will also create a further saving as it will allow £2,500 more of your dividend drawings to be taxed at the basic rate band instead of higher rate.  £2,500 of dividends taxed at 8.75% rather than 33.75% will save £625 in taxes.

The contribution itself then attracts 20% tax relief within the pension fund.  This means that your payment of £10,000 turns into a £12,500 increase in pension savings.  This looks to be a winning position surely – paying 8.75% tax on dividends at Basic Rate but achieving an extra 20% tax saving in the pension?

There is another important factor to consider however, which is the company tax position.  Dividends are not a tax deductible expense for a company, they are paid from post-tax profits.  To be able to draw £10,000 of dividends to fund the pension contribution, the company therefore needs to have made £13,333 profit before tax and paid 25% Corporation Tax (£3,333) on this, leaving you with the £10,000 dividend drawing.

The “cost” to the company for funding your personal contribution to the pension is therefore £13,333.  Of the £10,000 dividend you will still have to pay 8.75% in dividends tax on this, taking a further £875 from your available funds. For this purpose we have assumed the taxes are paid from other available funds.

Cost of contribution:

Contribution: £10,000

Corporation Tax: £3,333

Personal Tax cost: £875

Less Additional Personal Tax Saving: £625

TOTAL COST: 13,583

Value of contribution within the pension:

Contribution: £10,000

Tax Credit: £2,500

TOTAL: £12,500

Therefore, in cash terms £1,083 is lost taxes.

Compare this to a company made contribution:

A company, or “employer” pension contribution is tax allowable for the company.  Therefore if the aim is to put £12,500 into your pension (as there is no Tax Credit given by HMRC direct to the pension) the company would pay £12,500 direct to the pension.  The company can save 25% Corporation Tax on the contribution made as an allowable expense, saving £3,125.  If we therefore restate the cost to benefit calculation this would look as follows:

Cost of contribution:

Contribution: £12,500

Less: Corporation Tax saved: £3,125

Personal Tax: n/a

TOTAL COST: 9,375

Value of contribution to pension:

Contribution: £12,500

Tax Credit: n/a

TOTAL: £12,500

Therefore, in cash terms £3,125 is gained from tax relief.

A powerful saving indeed!

The Verdict: For higher-rate taxpayers, company contributions are often a clear winner, offering substantial tax savings compared to personal contributions. By strategically using your limited company structure, you can maximise your pension savings while optimising your overall tax position.

Other benefits

Employer contributions to your pension offer more than just tax savings. Here are a few additional benefits to consider:

Overcome Personal Contribution Limits

Personal contributions are limited (in terms of tax savings to be made) by your “net relevant earnings” which is essentially how much you take in the form of salary or self-employment.

So if you have a director’s salary of £12,500 per year you can only get tax relief on personal contributions up to £12,500 per year.  Many company directors or owner managed business do not have a high enough Net Relevant Earnings to maximise their pension contributions personally, the maximum eligible for the 20% tax credit being £60,000 per year.

Company contributions bypass this restriction, allowing you to contribute more towards your retirement.

In Short: Employer pension contributions offer greater flexibility, higher contribution limits, and simplified tax planning compared to personal contributions. This makes them a valuable tool for anyone looking to maximise their retirement savings, regardless of their drawings strategies.

For personalised advice on pension contributions, book a free 1-2-1 with one of our advisers today. Simply email enquiries@a4g-llp.co.uk, call 01474 853 856 or submit the form below to arrange your meeting.