One of the many advantages of owning a limited company is the option to make tax-efficient contributions to a company director pension. You can make payments into a private pension from your personal earnings and directly through your company, both of which can provide impressive tax savings.
This guide will discuss the basics of pensions for company directors, including the types of contributions you can make, pension tax relief, and contribution limits. All figures stated below are based on the current tax rates for the 2023-24 tax year.
Pensions for company directors
Setting up a pension may not be your biggest priority when running and growing a business, but it’s important to start planning for retirement as early as you possibly can. You don’t have an employer to set up a workplace pension for you, so the responsibility lies solely with you.
As a company director, you have access to two types of pension – the State Pension and private (personal) pension schemes. The State Pension is unlikely to provide sufficient income when you retire, so it is highly advisable to set up a private director pension as well. That way, you can enjoy a more comfortable life after retirement.
Aside from offering financial security for your future, a private pension is also an incredibly tax-efficient way to extract profits from your company. This is because you can make contributions from your personal earnings (director’s salary) and your company profits, the latter of which provides the most significant tax benefits.
Let’s take a look at these in turn.
You can make personal contributions to a private pension through your PAYE director’s salary. What’s more, you will get a 20% tax relief bonus from the government on every contribution you make.
For example, if you pay in £100, the government will add £20 to your pension pot. Your tax relief will be even more if you are a higher-rate (40%) or additional-rate (45%) taxpayer.
This ‘bonus’ offsets the Income Tax that is deducted from your salary through PAYE before contributions are paid into your director pension. Essentially, it is a refund of the tax that you have paid to HMRC. The government provides this bonus to encourage people to save for their retirement.
However, these tax-free contributions are limited to an ‘annual pension allowance’ of £60,000, which is tied to your salary, and a ‘lifetime pension allowance’ of £1,073,100.
Furthermore, if you are an additional-rate taxpayer, you will be subject to a tapered (reduced) annual pension allowance on income above a certain amount.
Can I make pension contributions from dividend income?
You can make additional personal contributions from your dividend income, but this is not recommended for the following reasons:
- You won’t get any tax relief on pension contributions from dividend income
- Dividends are paid from company profits after the deduction of Corporation Tax
- You will pay dividend tax on dividend income above your £1,000 annual dividend allowance
For these reasons, it is best to make personal contributions into your pension pot from your PAYE director’s salary, rather than dividends.
However, most company directors only pay themselves a relatively small salary, typically up to the tax-free annual Personal Allowance of £12,570, then take the rest of their income as dividends.
Whilst this arrangement is the most tax-efficient way to pay yourself through a company, your personal pension contributions from your salary will be far below the £60,000 annual pension allowance.
The solution is to make additional pension contributions directly from your company. This will provide more favourable tax benefits than increasing your director’s salary or using pre-taxed dividend income to top up your pension savings.
Pension contributions made directly from your limited company are not restricted to the salary threshold and annual pension allowance limit.
Consequently, you can pay more than £60,000 per year into your director pension pot, as long as the total amount does not exceed your company’s annual profits.
For example, if your company makes £25,000 profit in a single tax year, £25,000 would likely be the maximum amount that the company could legitimately contribute to your director pension.
HMRC treats pension contributions as an allowable business expense if the payments are ‘wholly and exclusively’ for the purposes of the profession, trade, or vocation.
This means that you can offset the contributions against your business profits and reduce your company’s Corporation Tax bill, which provides tax relief of 19% to 25% (depending on your company’s annual profits and, thus, the rate of Corporation Tax it pays).
Moreover, unlike personal payments from your salary, pension contributions from your company are not liable for Income Tax, National Insurance, or dividend tax.
On account of the Corporation Tax saving, however, you will not receive any ‘annual allowance’ tax relief on these company contributions when they arrive in your director pension.
What is the maximum amount I can contribute to a director pension?
In the UK, there is no hard limit on the amount of money you contribute to a private pension – you can pay in as much as you like.
However, as previously mentioned, there are two thresholds that do limit the amount of tax relief you can receive on these pension contributions:
- Annual allowance
- Lifetime allowance
Annual pension allowance
Private pensions are subject to an annual pension allowance of £60,000, or 100% of your gross PAYE salary earnings – whichever is lower.
This is the most that you can you contribute to your director pension in a tax year before you have to pay tax. It includes both personal and company contributions, as well as the tax relief that the government adds to your pension pot.
If your director’s salary is £60,000 or more, the maximum amount that you can contribute to your pension in the current year and get tax relief is £48,000. The remaining £12,000 will come from the government’s 20% tax relief bonus.
If your director’s salary is £12,570, the most that you can personally pay into your pension in the current year and get tax relief is £12,570. The government will then add a 20% tax relief bonus of £2,514.
However, you will be subject to a tapered annual pension allowance if:
- your ‘threshold income’ is above £200,000, and
- your ‘adjusted income’ is above £260,000
If you meet these income requirements, your annual allowance will reduce (taper) by £1 for every £2 of adjusted income above £260,000.
For example, if your adjusted income is £280,000, your annual pension allowance will reduce to £50,000.
This tapering stops at £360,000, which means that everyone receives an annual pension allowance of at least £10,000.
If you use up the full allowance for the current tax year, you may be able to carry forward any unused annual allowance from the previous three tax years. We discuss these ‘carry forward’ rules in more detail later in the post.
For tax years up to and including 2022-2023, the threshold income and adjusted income limits are different.
Lifetime pension allowance
In addition to the annual pension allowance, contributions are subject to a lifetime allowance. This is the maximum amount you can pay into private pensions over the course of your lifetime whilst still benefiting from tax relief.
The current lifetime limit is £1,073,100, which applies to your pension contributions and any growth on these investments. If you have more than one private pension, you must add up the total allowance you have used across all of your pension schemes.
If you took your pension before 6 April 2023 and your savings exceed the threshold, you may have to pay additional tax on pension savings above your lifetime allowance. The rates are:
- 55% if you receive your pension savings as a lump sum
- 25% if you receive your pension savings in any other way – e.g. pension payments or cash withdrawals
Your pension provider(s) will tell you how much tax you owe and make the necessary deductions if your contributions go above your lifetime allowance.
However, If you take your pension on or after 6 April 2023, no lifetime allowance charge will apply. Instead, you will pay Income Tax on some or all of the lump sum. Your pension provider will deduct the charge before you get your payment.
If your pension contributions exceed the annual allowance
It is your responsibility to keep track of your total pension contributions. If you exceed the pensions annual allowance in a tax year, your pension provider will send you a statement to notify you.
In such instances, either you or your pension provider will have to pay the ‘pensions annual allowance tax charge’ on the excess contributions.
You will need to declare this in the ‘Pension savings tax charges’ section on your next Self Assessment tax return, even if your pension provider pays some or all of the charge.
Generally, the rate of the charge will be linked to the highest rate of Income Tax that you pay.
How to claim tax relief on a director pension
Claiming tax relief on a director pension is relatively easy for most people.
When you make personal contributions, your pension provider will claim the first 20% tax relief on your behalf, known as a ‘relief at source’. This is equivalent to the basic rate of Income Tax, which you will have already paid on your salary through PAYE.
When the government approves the claim, your tax bonus will be automatically added to your pension pot within approximately two to three months.
However, if you are a higher-rate or additional-rate taxpayer, you will need to personally claim your additional relief when you file your Self Assessment tax return. Higher-rate taxpayers can claim an extra 20%, whilst additional-rate taxpayers can claim a further 25%.
If you do not receive your tax relief automatically, or you don’t claim the additional tax relief that you are entitled to, you can backdate your tax relief claims up to four years.
Carry forward rules – claiming unused annual pension allowance
In certain situations, you may be able to ‘carry forward’ any unused annual pension allowance from the previous three tax years.
This means you can exceed your annual allowance and still benefit from the tax relief bonus if you didn’t make the maximum contribution in any or all of the last three years.
For example, if you didn’t pay anything into your pension for the previous three years, you can make a backdated contribution of up to £140,000, including tax relief.
Carry forward eligibility
To be eligible to carry forward, you will need to satisfy the following conditions:
- You must have been a member of at least one UK-registered pension scheme or a qualifying overseas pension scheme during the relevant tax years you wish to carry forward. The State Pension does not count in this instance.
- You must earn at least the amount that you wish to contribute in the current tax year. For example, if want to make a total contribution of £140,000, you must earn at least £140,000 in the tax year you are making the payment.
The carry forward rules are particularly useful if:
- You earn more than £60,000
- Your earnings fluctuate each year
- Business expenses were unusually high or profits were low in one or more of the previous three tax years, preventing you from making the maximum pension contributions
- Your company profits have increased significantly and you would like to invest some of this money in your pension
- Your earnings in the current tax year are subject to the tapered annual allowance and you would like to top up your pension savings
HMRC provides an online pension annual allowance calculator, which you can use to work out whether you have any unused annual allowance available to carry forward. You can also use this calculator to check if you have an annual allowance tax charge on your pension savings.
These calculations can be complicated, so we recommend speaking to an accountant or tax specialist for expert help and guidance if you want to take advantage of the carry forward rules for your director pension.
How do I qualify for the State Pension?
The State Pension is a small, regular payment that the government provides to most people when they reach the State Pension age.
The amount that you get depends on your National Insurance contributions (NIC), with the maximum sum currently sitting at £203.85 per week or £10,600 a year, which is paid every four weeks.
To receive the full State Pension, you must have 35 ‘qualifying years’ of NIC. To be eligible for any State Pension at all, you will usually require at least 10 qualifying years.
Even if you are eligible for the full amount, it will be wholly inadequate to fund a comfortable retirement. This is why it is imperative that you set up a private director pension and take advantage of the tax reliefs available on your personal and company contributions.
You can check your State Pension forecast on GOV.UK to see how much you are likely to receive. It is also worth checking your National insurance record online to determine whether there are any gaps in your NIC record and if you are eligible to make voluntary contributions to fill any such gaps.
Setting up a company director pension is one of the most tax-efficient ways to extract profit from your business and accumulate much-needed wealth for your retirement.
You will benefit from significant tax savings and tax reliefs if you plan your pension contributions properly, making a combination of payments through your director’s salary and directly from company profits.
Pensions are notoriously complex, so we strongly recommend that you consult an accountant, financial advisor, or tax specialist to discuss your options. They can help you find director pension schemes to suit your needs, and advise on the best strategy for making regular contributions to your pension savings.
If you have any questions about this post or any other aspect of setting up and running a limited company, please leave a comment below or contact our company formation team.