Pensions offer UK residents fantastic tax incentives to save and invest with a view to building up a large capital sum that can be used to fund any period post age 55.
The principle tax incentive comes in the form of income tax relief on an individual’s ‘net relevant earnings’. For most employees, this means their salary and any bonuses they receive from their employer.
However for many business owners who draw a small salary in conjunction with dividends based on their profits, the ‘Net Relevant Earnings’ rules can mean personally funded pensions are not workable. This is because dividends are not ‘tax relievable’ for pension funding purposes, so the maximum personal contribution is limited to the amount of the small salary drawn.
One way to circumvent this issue is to establish a suitable ‘Director’s Pension’ and have the company make the contributions on the employee’s behalf. Contributions can then be deemed as employer payments and are subject to different rules for taxation.
Employer contributions are considered business expenses so are deductable as an expense for the calculation of corporation tax. In contrast to salary payments, there are no employee or employer national insurance due on pension contributions. There is also no tax liability on the employee up to the annual allowance threshold of £50,000 per annum.
Once the Director’s Pension structure is properly established, a business owner can use it to transfer wealth from his or her company directly into their personal domain with no immediate taxation. This is an especially attractive prospect for otherwise higher or additional rate tax payers as it provides another tax efficient remuneration strategy to avoid large income tax deductions.
If a husband and wife are both business owners then both may be eligible to fund for retirement via the limited company structure.