Pension contributions can be a great way to save tax.
Decisions about whether or not to make pension contributions should normally be led by investment considerations and our clients generally use financial advisers to decide whether or not to contribute as the money will usually be locked away and there can be various risks involved as well.
We can only comment on the tax side. We are able to recommend a financial adviser if needed.
There are 2 main forms of tax savings that are usually relevant to our clients:
1) personal contributions: tax relief at source to increase the pension pot and also an increase in the 20% tax band will reduce the amount of 40% or 45% tax paid and result in a tax refund in the self assessment.
2) corporation tax: employers pension contributions are tax deductible, so the company will save tax at 19% (in 2021) on the amount of contributions paid.
There is an annual allowance of £40,000 that is eligible for tax relief and this includes both employer contributions and also amounts that clients contribute personally, based on the tax year upto 5 April each year.
Clients can also carry over unused allowances from the previous 3 years if they need to invest more.
However, it should be noted that personal contributions are limited to an individual’s earnings, although the company can contribute an extra amount to utilise the £40k allowance. If there are no taxable UK earnings, the limit is much less (£2,800 gross in 2021/22).
There are some other circumstances, please check HMRC to confirm, for example if individuals earn more than £200,000 a year.
Personal pension contributions are typically made from net pay (after tax) via payroll into a company scheme or from paying separately into a personal plan (eg SIPP).
Our clients will generally receive 20% “relief at source” on their pension contributions automatically by their pension scheme as the provider adds 20% to the pension pot.
When completing their self assessment, we need to enter the gross payments into the tax return, which is the actual contributions paid plus 20%.
If they’re a 40% or 45% taxpayer they’ll also then receive a tax refund as the higher rate tax band will be increased by the gross contributions.
Pension statements show personal contributions of £8,000 in the tax year. This is declared in the tax return as the gross value £8,000 /80%*100% = £10,000. This will result in a tax refund of £10,000*20% = £2,000 if they’re a 40% taxpayer or £10,000*25%= £2,500 if they’re a 45% taxpayer.
The company will get a corporation tax deduction on its contributions into registered pension schemes and there will not be any income tax or NIC payable on employer contributions.
There needs to be a contractual arrangement/obligation for the company to make a separate contribution to the client’s personal contributions, whether its into a company pension scheme or a personal SIPP or pension plan.
So to save corporation tax, the client has to show that the company is making an employer’s contribution.
Our clients usually explain to their pension provider that they want to make an employer’s contribution before making the payment. This is important because we need some documentation from the pension provider to prove that its an employer’s contribution.
The contributions can be made throughout the accounting year or as a lump sum, but the company will obtain the corporation tax deduction in the accounting period in which the company pays the contributions.
The pension contributions cannot be accrued or backdated.
The contributions can also be included R&D tax credit claims (for the proportion of time spent on eligible R&D projects)
Director salary is £8,000 and has a personal SIPP and no auto enrolment. Although the salary is low, the company can still pay £40,000 into the SIPP as long as the correct forms are filled in to show its an employer’s contribution. Tax relief in 2019 would be £40,000*19%.
If the company year end is 31 December, £40k could be paid in March and another £40k in December to maximise contributions in this particular accounting year, as it straddles the 5 April tax year end used for the £40k allowance.
Income from state & other pensions:
These are usually taxable and need to be included in the self assessment tax return.
State pensions: the client should have a letter with their weekly State Pension amount
Other pensions: the client should have a P60 or similar annual statement, the total gross amount before tax needs to be declared in the self assessment.
Pensions can be very complex. Further advice should be sought from a partner at MAH if dealing with:
- something different to the examples and explanations above
- early/flexible access to pension pots & lump sum payments/refunds
- overseas pension schemes
(Notes from HMRC manuals are below)
A pension contribution by an employer to a registered pension scheme in respect of any director or employee will be an allowable expense unless there is a non-trade purpose for the payment.
contributions are paid wholly and exclusively for the purposes of the trade where the remuneration package paid in respect of a director of a close company, or an employee who is a close relative or friend of the director or proprietor (where the business is unincorporated) is comparable with that paid to unconnected employees performing duties of similar value.
Section 308 ITEPA 2003 provides that an individual is not liable to income tax where an employer makes a payment to a registered pension scheme (“RPS”; NIM02715). Where that section applies, such a payment is disregarded in the calculation of earnings for Class 1 NICs purposes.
registered personal pension scheme arrangements made by an employee (or director) may provide for employer contributions as well as employee contributions. Where, under such arrangements, the employer pays employer’s contributions the contributions are not chargeable on the employee as earnings of the employment (Section 308 ITEPA 2003).
a deduction can only be given for the period in which the contribution is paid.
I make regular accruals regarding pension costs in my company accounts, can relief be given in respect of these accrued amounts?
No. Tax relief can only be given on contributions that have actually been paid. The amount shown in the profit and loss account in respect of obligations in respect of defined benefit schemes may be substantially different from the amount of contributions paid to the scheme. But it is only the amount actually paid that can be considered for tax relief.