Is your business your pension?

1 November 2021

Taking out an actual pension can diversify your risk and is a tax-efficient way to take money from your company.

Entrepreneurs often assume that their business will make enough money for a comfortable retirement – but what if things don’t go to plan? If you are relying entirely on your company and it fails or doesn’t perform as well as you’d hoped, you could be left with very little in later life.

With uncertain trading conditions over the next few years, a pension is a useful way to spread your risk away from your business and is an extremely tax-efficient method of extracting capital from it. That’s because of the very generous tax relief that companies enjoy on pension contributions.

Corporation tax is currently 19%, so for every £100 your company earns as profit, you’ll pay corporation tax of £19, reducing the amount you can take as a dividend to just £81. But when the company pays £100 into your pension, it effectively only costs £81 because of a reduction in corporation tax.

Reducing Income Tax

In addition, a pension allows you to take a comparatively large sum without being liable for higher-rate income tax. You could, for example, pay yourself salary and dividends of £50,270 and the company could pay up to the annual tax-free allowance of £40,000 (or 100% of earnings if less) into your pension. In fact, you can carry forward any unused annual allowance from the previous three years, meaning that the company could potentially pay you a pension contribution of up to £160,000 in a single year, with a corresponding reduction in corporation tax.

For the contributions to be an allowable expense, they would need to meet the ‘wholly and exclusively’ test. Essentially, this means the contribution must be commensurate for the work undertaken by the individual receiving the pension payment.

Simon Martin, Technical Connection Consultant at St. James’s Place, explains: “A typical company founder might say, ‘My business is my pension.’ That’s fine as long as it continues to be successful. But if, for various reasons, the business struggles, not only may your lifestyle be affected, but your retirement will be impacted as well. If you have a pension, even if your company fails at some point in the future, the pension funds can still be held for your retirement. It’s a way of protecting yourself and your future.”

Tax-efficient Extraction

Pensions are not the only way to draw money from your company tax efficiently. It is important to ensure your remuneration structure is tax efficient as this will impact the net income received from your business. Consideration should be given to all of the available allowances and exemptions, such as the personal allowance and dividend allowance.

The personal allowance is currently £12,570 and the dividend allowance is £2,000. Income within these bands can be taken from your company without a charge to income tax. Dividend income within the basic-rate band is taxed at 7.5% with no employer’s or employee’s National Insurance; often using dividends is a tax-efficient means of drawing profits from your company.

Speak to your accountant for advice on creating a tax-efficient remuneration structure for your business, and get in contact with us for advice on planning for your retirement.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances. Allowances based on 2021/2022 tax year.

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