Business owners frequently make significant sacrifices in order to expand their enterprises. When their business is successful, they want to reward their success by taking a reasonable level of income.
This has typically meant taking dividends to extract earnings for directors who own shares because, when compared to salaries or perks in kind, dividends have historically given shareholder directors the highest net income.
Since April 2016, the government has increased the rate of tax and therefore reduced the personal tax benefits of dividends for director shareholders.
If a director has sufficient capital or income from other sources, then they need to review the following (to determine if there are more profitable options):
- Legislation
- Personal circumstances
- The financial health of the company
After this, he or she may decide to eliminate or lower dividend payments in favour of making pension contributions.
Flexibility
There are two ways to pay your pension contributions: directly from your company on your behalf or personally.
A drawback of using pensions instead of dividends is the inability to withdraw funds from your pension until you are 55 or older.
Advantages
You may be eligible to carry forward any unused Annual Allowance if you haven’t contributed the entire Annual Allowance to your pension throughout the years, which is presently set at £60,000.
To calculate the maximum amount that can be paid, you would need a “carry forward” calculation; that’s the technical term for catching up on any unused annual allowance contributions you could have made over the previous three years.
Providing your company pays the pension contributions, such payments would reduce your company’s corporation tax burden.
Review with a knowledgeable adviser
For our business-owner clients, we encourage them to attend planning meetings at least once a quarter. One of the meetings should be two months before the company’s year-end.
Try to avoid making abnormally high pension contributions. Your total earnings, including any pension contributions made by the company (if any), shouldn’t be significantly higher than the average for businesses like yours. Otherwise, HMRC may investigate and dispute the validity of the contributions under the “wholly and exclusively” criteria.
If so, consider spreading the payment of pension contributions over consecutive trading years.
Example
Roger is a director shareholder and earns more than £50,270, making him a high-rate taxpayer.
He wants to know the tax difference between paying a £1,000 dividend or, alternatively, getting the company to pay £1,000 in pension contributions.
Dividends do not benefit from Corporation Tax Relief, so the company will pay 19% of the £1,000, leaving a net £810 as distribution, on which Roger would be taxed at 33.75%, so the net benefit of the £1,000 dividend is only £537.
If the company were to pay £1,000 to Roger’s pension, it would benefit from a corporation tax deduction of 19%. When he withdraws money from his pension, the £1,000 would provide £250 tax-free, and the balance would be taxed at Roger’s marginal rate of tax.
If your company pays a higher rate of corporation tax, then the tax benefit for the company will be higher, although the personal tax position on withdrawal has not altered.
Ongoing Strategic Direction
Director shareholders should consider a proper remuneration strategy as part of the advance financial planning that they should be receiving on an ongoing basis.
Full strategic planning can not only provide tax savings but also assist the company in achieving higher growth, as well as improve the personal wealth of the shareholder director.
