For owner managers of dividend paying companies there is a marginal tax saving of 1% by making a company (employer) pension contribution compared to a personal pension contribution.
For example if your company could pay £12500 into a pension scheme there is no tax charge on you. There is simply £12500 going into your pension scheme.
The company could instead pay tax at the new rate (from 1 April 2017) at 19% on £12,500 of profits leaving £10,125 that can be paid as a dividend.
- For a basic rate tax payer there will be 7.5% dividend tax to be paid on this leaving £9,366 extra after tax money. To get £12500 into the pension scheme (gross contribution) we have to pay in £10,000 net contribution (the government top up personal pension contributions to allow for basic rate tax). This leaves the basic rate tax payer £636 worse off by making personal pension contributions compared to a company pension contribution (in both cases putting £12500 into the pension scheme).
- For a higher rate tax payer the personal pension contribution has the added benefit of extending the basic rate band by the grossed up pension contribution. The overall affect of this is to leave the higher rate tax payer £40 worse off by making personal pension contributions compared to a company pension contribution (in both cases putting £12500 into the pension scheme).
As can be seen, the figures suggest a basic rate tax payer would go for a company pension contribution benefiting from this decision by over 5% of the pension amount. A higher rate tax payer would also benefit from the same decision but only marginally.
An important additional benefit of a company (employer) contribution from an owner managed company compared to a personal pension is that a company contribution itself counts as earnings when calculating the maximum pension contribution for an individual. In other words in most situations the company contribution is not not limited by earnings whereas as the personal pension contribution is.
For companies that cannot pay dividends to the directors (e.g. now owner managed; or limited by guarantee; or no accumulated profits) the decision may be different. Assuming the company can make use of the tax relief on the pension it is likely the decision to make a company contribution over a personal one will be even more favourable. This is because the company contribution avoids national insurance on the pension amount whereas the personal pension contribution does not save national insurance.
As with all of our tax tips and web pages this information is necessarily summarised and of a general nature. If you would like detailed specific advice please contact us.