Following on from my last blog where I talked about pension contributions using Carry Forward for an employed person this time I would like to write about how this can be used for owner directors. In this current tax year 2017/2018 it is possible to contribute up to the current annual allowance of £40,000 or up to £160,000 if using carry forward in to a pension in one lump sum payment.
The first thing to point out is the payment we would recommend for owner directors that take a large dividend and take a small salary is that pension payments are paid for by the company. This is due to the fact that you can only claim tax relief on employee contributions up to your annual salary plus taxable benefits. For example if you are taking a salary of £11,500 and receiving dividends of £30,000 per annum you can only make pension contributions of up to £11,500 and claim full tax relief. Unlike personal contributions, employer contributions aren’t limited by what someone earns. With employer contributions these are treated as an allowable expense and are offset against your company’s corporation tax bill.
If we take the example of a company with one director making a net profit of £100,000 and the company director paying himself a salary of £11,500, if the director takes what is left after corporation tax they would receive £68,414 as a benefit to them. As the net profit would be subject to corporation tax of 19% it will leave £81,000 to be taken as dividends. The first £5,000 of dividend income would not be subject to income tax. The rest of the dividend income is subject to a 7.5% dividend tax for funds that fall within the basic rate tax band and the higher dividend tax of 32.5% on income in the higher rate tax band.
This method can be very useful for putting large amounts into the pensions of connected persons such as family members working in the business. This amount, as well as being within the annual allowance limits, has to pass the ‘wholly and exclusively’ test for an employer contribution to benefit from corporation tax relief. HMRC's view is that contributions to a registered pension scheme will normally be allowed and that it would be 'relatively rare' for a pension contribution not to be for the purpose of the employer's trade. A contribution would not be allowable if there is an identifiable non-business purpose for the employer's decision to make the pension contribution or for the size of the contribution.
The table below is a reminder of how the carry forward calculation would work with the £100,000 contribution but as an employer contribution.
Points to note are that tax relief can only be given on contributions that have actually been paid. A contribution can also normally only be treated as a deduction for the accounting period in which the contribution is paid. For any further financial planning recommendations please feel free to visit www.bradburyhamilton.co.uk or call Sheriar Bradbury on 020 7220 7274.