Why business owners could benefit from putting profits into their pensions

If you are the boss of your own company, you’ll know there are plenty of challenges in running your own show. You may sometimes envy your employed friends, who don’t have the same responsibilities and, moreover, could receive contributions to their pensions from their employers.

In contrast, company owners have to concern themselves with contributing into pensions for employees who qualify under complex autoenrolment rules. Qualified employees generally include people between the age of 22 and the state pension age who earn around £10,000 a year or more (1).

Qualifying employees have to be enrolled in a workplace pension scheme. But directors of limited companies without employees can apply to HMRC for exemptions from setting up pensions for themselves. Around three-quarters of all businesses consisted of just the business owners in 2022 (2). And nearly half of micro companies (those with four employees or less) did not offer a pension plan in 2019 (3). So it appears many businesses without employees are using this exemption.

Paying into a pension could save company tax

But many solo directors or company owners who apply for pension scheme exemption could miss out on a key benefit: getting your company to pay into a pension scheme for you. This benefit could, potentially, be very valuable indeed.

That’s because company pension payments are a tax-deductible expense. So they could reduce your company’s corporation tax liability and employer’s national insurance payments (in line with how much salary you pay yourself). They could also reduce tax on any dividends you may receive from the company.

How it works: a case study for a higher-rate taxpayer

Ali is a director of his own company that has no other employees. He pays tax at the higher rate of 40 percent. Ali has applied for an exemption from setting up a pension scheme as his income is sporadic and he doesn’t want to have to commit to paying regular fixed sums.

This year his company made a profit of £40,000, which Ali wants to take as a dividend payment to himself. As this profit is less than £50,000 it is subject to HMRC’s 19 percent ‘small profits’ corporation tax rate (4), leading to a £7,600 corporation tax payment. This leaves £32,400 of profits available to distribute as a dividend.

Moreover, Ali would pay a further 33.75 percent in higher-rate tax on the amount, above his annual dividend allowance of £1,000 for 2023/24 (5). This would amount to a tax payment of £10,598.

So, for Ali, the profit of £40,000 would be subject to a total of £18,198 in tax, leaving him with just £21,802.

Alternatively, he could get his company to put it into a pension scheme for him. The full £40,000 could go into his pension, without paying corporation tax on the company profits or income tax on the dividend, as this is a tax-deductible expense.

Company pension payments are not limited by salary

Using your company to pay into your pension means there’s no ‘salary threshold’ limitation. If you’re paying into your pension fund yourself, you can’t pay in more than you’ve earned in salary, and dividends don’t count as salary. So if you earn £35,000 a year you can only contribute a maximum of £35,000 to your pension. In contrast, company contributions can take full advantage of the annual pensions savings allowance offered by HMRC, which, for the 2024/25 tax year, is £60,000 (6).

So you could opt to take a reduced salary and not make any personal pension contributions, if that suits your circumstances. You could, then, still take your dividends, but your business could put up to £60,000 per year into your company pension. Moreover, any unused allowances could potentially be carried forward for three years.

Pension payments by your company are an allowable business expense. So your company doesn’t pay corporation tax or employers’ national insurance on them, and you don’t have any income tax liability. But HMRC must consider these company pension contributions to be ‘reasonable’. For example, they can’t exceed the company’s annual profits and, if you have employees, then similar contributions should be paid to others in the company doing similar work.

Running your own company can be stressful and time-consuming. It can be hard to look beyond day-to-day concerns and consider your future financial wellbeing. But, for company owners, money that could have been lost to tax could instead potentially help pay for a more comfortable retirement.

This is, however, a complex area and you may benefit from taking specialist assistance. A tax adviser, accountant, or financial adviser may be able help you to weigh up your options and ensure your decisions match your circumstances. At Schroders Personal Wealth, one of our key principles is having regular reviews with an adviser, to help ensure your financial arrangements remain in line with your life goals.

Sources:

(1) The Pensions Regulator (www.thepensionsregulator.gov.uk), ‘Duties for new employers’, 28 December 2023.

(2) Department of Business, Energy and Industrial Strategy (www.gov.uk), ‘Business population estimates for the UK and regions 2022: statistical release’, 6 October 2022.

(3) Department for Work and Pensions (www.gov.uk), ‘Employers’ Pension Provision Survey 2019’, 28 June 2022.

(4) HMRC (www.gov.uk), ‘Corporation tax rates and allowances’, 21 December 2023.

(5) Gov.uk, ‘Tax on dividends’, 28 December 2023.

(6) Gov.uk, ‘Tax on your private pension contributions’, 28 December 2023.