Company or personal pension contributions
Probably the best way to determine whether company or personal pension contributions should be made is to work through some examples and these are set out below:
Pension contribution paid by the company
Picard Ltd pays £25,000 directly into the director's scheme and it obtains Corporation Tax relief at 25% or £6,250. This means the net cost of the pension contribution is £18,750.
Director pension contribution from salary
The tax position will depend very much on whether the employee is either a basic rate or higher rate taxpayer.
Fox Ltd wishes to pays it's director Mulder, who is a basic rate taxpayer, sufficient bonus for him to make a gross personal pension contribution of £25,000.
The company therefore pays Mulder a gross bonus of £29,411 and Employer's National Insurance of £4,059. This amounts to a total cost to the company of £33,470 and it will obtain corporation tax relief of £8,367.50 on the bonus. The net cost to the company is therefore £25,102.50 (£33,470 less £25,102.50).
Mulder the director suffers £9,411 in tax and National Insurance leaving £20,000 as a net bonus. He then pays £20,000 into a personal pension. The pension provider claims £5,000 from the government and the gross pension contribution amounts to £25,000.
Scully Ltd wishes to pays it's director Dana, who is a higher rate taxpayer, sufficient bonus for her to make a gross personal pension contribution of £25,000.
The company therefore pays Dana a gross bonus of £34,483 and Employer's National Insurance of £4,759. This amounts to a total cost to the company of £39,242 and it will obtain corporation tax relief of £9,810.50 on the bonus. The net cost is therefore £29,432 (£39,242 less £9,810.50).
Dana the director suffers £14,483 in tax and National Insurance leaving £20,000 as a net bonus. She then pays £20,000 into a personal pension. The pension provider claims £5,000 from the government and the gross pension contribution amounts to £25,000.
Dana pays £20,000 into a personal pension. The pension provider claims £5,000 from the government and the gross pension contribution amounts to £25,000. She also claims additional income tax relief on the pension contribution of £5,000. The net cost is therefore £24,432 (£39,242 less £9,810.50, less £5,000).
Director pension contribution from dividends
It is important to note that dividends are not considered relevant earnings for the purposes of claiming tax relief on pension contributions. Therefore if you want to make additional pension contributions the total amount must not exceed the level of your salary. If you have no salary, then the maximum tax-relieved contribution you can make as an individual is £3,600 per year.
Assuming you have a £25k salary and take the balance as dividends, would it be better for your company to make a £25k pension contribution or should you make the £25K contribution personally? This assumes no pension contributions have been made.
If the company makes a pension contribution of £25,000 directly to the provider, it saves tax (at 25% on the contribution) of £6,250 and the net cost is £18,750.
Alternatively, your company could pay an extra dividend (out of post tax profits) in order for you to make the equivalent £25,000 contribution to the pension provider.
In this instance a gross dividend of £21,917 would be paid by your company which after tax would equate to a £20K dividend. You would make the contribution of £20K net to the provider (£5K being claimed from the government).
Income Tax of £1,917 is payable by you on the extra dividend (at 8.75%, taking into account the extended basic rate band). This is financed by the difference between the dividend (£21,917 and the cash pension contribution made (£20,000).
The net cost of the personal pension contribution is £21,917 being the dividend paid out of the company's post tax profits..
The question of whether to make company or personal pension contributions can be summarised as set out below.
If you own your own company, getting your company to make a pension contribution directly may be preferable as it is the least expensive and leaves the most profits available for distribution to you as the company shareholder.
However, If you are employed by someone else's company, being paid a bonus may be the best choice, particularly if it may be useful to be able to show high earnings in a year, for example, if you are applying for a mortgage
If you do decide to pay yourself extra dividends to fund additional contributions, the higher rate of tax for dividends does makes a personal contribution a more expensive option.
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