Why pen­sion route can pay div­i­dends in long run

Birmingham Post - - PERSONAL FINANCE -

div­i­dend op­tion be­com­ing more ex­pen­sive, it still re­mains bet­ter than salary for most di­rec­tors with­draw­ing prof­its sig­nif­i­cantly above the an­nual div­i­dend al­lowance.

“For a higher-rate tax­payer, the com­bined ef­fect of cor­po­ra­tion tax at 19 per cent and div­i­dend tax of 32.5 per cent will still yield a bet­ter out­come than pay­ing it out as salary, which needs to ac­count for in­come tax at 40 per cent, plus em­ployer Na­tional In­sur­ance (NI) of 13.8 per cent and em­ployee NI of two per cent. How­ever, an em­ployer pen­sion con­tri­bu­tion means that there’s no em­ployer or em­ployee NI li­a­bil­ity – just like div­i­dends. But it’s usu­ally an al­low­able de­duc­tion for cor­po­ra­tion tax – like salary.”

Many busi­ness own­ers cur­rently pay them­selves a small salary, typ­i­cally around £8,000 and take the rest of their an­nual in­come needs in the form of a div­i­dend.

The dan­ger is that this could see their an­nual al­lowance (AA) ta­pered down to just £10,000.

“How­ever, by re­duc­ing what they take in salary or div­i­dends and pay­ing them­selves a larger pen­sion con­tri­bu­tion in­stead could mean they re­tain their full £40,000 AA,” noted Stan­dard Life. It works like this: Ad­justed in­come (to­tal in­come plus em­ployer pen­sion con­tri­bu­tion) – if this is more than £150,000, the AA is re­duced by £1 for ev­ery £2 over the limit, sub­ject to a min­i­mum al­lowance of £10,000.

Thresh­old in­come (to­tal in­come with­out em­ployer pen­sion con­tri­bu­tions) – if this is less than £110,000, there will be no ta­per­ing and the full £40,000 al­lowance will be avail­able.

To fur­ther em­pha­sise the tax ef­fi­ciency of em­ployer pen­sion con­tri­bu­tions, busi­ness own­ers who are aged 55 or more, are able to ac­cess pen­sion monies im­me­di­ately us­ing the pen­sion free­dom leg­is­la­tion. When with­draw­ing pen­sion ben­e­fits, bear in mind the Life­time Al­lowance limit ap­pli­ca­ble (cur­rently £1 mil­lion), and ben­e­fits taken in ex­cess of the 25 per cent tax-free lump sum al­lowance from the fund will trig­ger the Money Pur­chase An­nual Al­lowance (MPAA), which re­stricts fu­ture fund­ing to £4,000 per year.

There are also the in­her­i­tance tax (IHT) ad­van­tages of pen­sion monies. These in­clude:

Pen­sion monies are usu­ally out­side of a per­son’s Es­tate for IHT pur­poses, as­sum­ing such ben­e­fits are within the Life­time Al­lowance.

Death of the pen­sion mem­ber be­fore age 75 al­lows for the in­her­it­ing ben­e­fi­cia­ries to ac­cess the ben­e­fits in their own name tax-free.

Death of the pen­sion mem­ber af­ter age 75 is passed to ben­e­fi­cia­ries tax-free but any monies with­drawn is as­sessed for tax at their mar­ginal rate.

Other tax plan­ning op­por­tu­ni­ties, where the pen­sion route can be used in­stead of salary or div­i­dend, are for ex­am­ple where salary or div­i­dend boosts in­come to the point where the Per­sonal Al­lowance is lost or Child Ben­e­fit is lost.

So, in sum­mary, care­ful tax plan­ning can mean you avoid AA taper, use your full pen­sion al­lowance, and de­liver more tax ef­fi­cient in­come, all while get­ting in shape for re­tire­ment.

A pack­age that is def­i­nitely worth ex­plor­ing fur­ther with your pen­sion or tax ad­viser. Trevor Law is man­ag­ing di­rec­tor of East­cote Wealth Man­age­ment, char­tered fi­nan­cial plan­ners,

based in Soli­hull. Email: tlaw@east­cotewealth.co.uk

The views ex­pressed in this ar­ti­cle should not be con­strued as fi­nan­cial ad­vice

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