Why pension route can pay dividends in long run
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: email@example.com
The views expressed in this article should not be construed as financial advice