Tax efficient remuneration using pension contributions

Advice, Talent and Tax

December 20, 2018

Pension contributions can be a tax efficient way of increasing pay packages of your employees. With generous reliefs from the government they are a win-win.

Tax relief on pension contributions costs the government £38bn a year, so some expected the Chancellor to cut tax relief in the 2018 Autumn Budget.

However, there were no changes. The generous tax reliefs will continue to apply. Currently, tax relief is available for those who pay the highest rate of income tax (40%), basic rate of income tax (20%) and additional income tax rate (45%). Even those who do not pay tax can take advantage of tax relief on pension contributions up to a maximum amount of £3,600 per year. This means that a non-tax payer can contribute £2,880 a year but £3,660 will be invested by their pension provider.

The calculation for pension contributions is applied using ‘relevant UK earnings’ which for most people consists of their salary. If you own a limited company and are paid a salary as well as dividends. Only the salary will count as ‘relevant UK earnings’. Therefore, it is beneficial to allocate a bigger proportion of your remuneration to salary and not dividends as the higher your salary is the more relief you can obtain. The limit within which you can claim tax relief is £1,030,000 for the tax year 2018-19. Anything above this amount will incur tax charges of 25% if paid as a pension or 55% if paid as a lump sum.

Benefits for the company

In order to increase your tax-free contribution limit, you can increase your salary, or the company can make a contribution directly into your pension. If your company contributes to your pension it can take advantage of a reduction in corporation tax of up to 19% as long as the contributions are an allowable business expense (i.e. they are wholly and exclusively for the purpose of business).

The company will also benefit from not having to pay National Insurance Contributions which are 13.8% of the contribution amount.

This means that in total a company can save up to 32.8% by paying directly into your pension contributions. Furthermore, which path you decide to take will depend on your particular circumstances: there are specific factors which affect the level of benefits you are exposed to.

Benefits for employees

The main benefit of a pension plan for any employee is that it helps you to save money which you can receive once you retire. Employers can contribute to their employees’ pension schemes without incurring tax charges. For this reason, a noticeable level of contributions can be rewarding for employees as it enhances their overall remuneration packages. Furthermore, subject to meeting certain conditions, an employee may be able to cover the first £500 of pension advice through a relatively new income tax exemption.

It is difficult to predict whether or not there will be any government policies which cause a change to tax relief on pension contributions in the near future, but now is better time than any to top up your pension pot.

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