Self Employed, Pension and Tax Query.

philrush

Hi,

I'm a little confused how pensions work in relation to tax, as I have just started a pension last tax year.

My earning are through a company so I pay corp tax, then set my wage at below the threshold for the higher tax band on dividends, which is £32,010 plus 10%, plus my personal allowance, which gives me £41540 a year before the higher rate on dividends kicks in (32.5%)

If I am investing an additional £5,000 a year in a pension, does this make my earnings as £46540 thus taking me £5000 into the 32.5% dividend rate.

Or is the pension contribution treated as non taxed income, thus my real earnings are still seen as £41540, with a non taxed additional £5,000 I have put into a pension.

I know the government adds 20% already to pensions, but I'm wondering if there is a benefit in the way I have described.

Any help appreciated,

Thanks, Phil

dunstonh

First thing to state is that you are not self employed.

If I am investing an additional £5,000 a year in a pension, does this make my earnings as £46540 thus taking me £5000 into the 32.5% dividend rate.

As you have a limited company, it is usually best to get the company to pay the contributions rather than you personally. You avoid NI that way. You also avoid the annual allowance restrictions regarding maxing out against your earned income (which is typically low when you are director as you take the bulk of it in dividends which cannot be used as earnings against a pension).

I know the government adds 20% already to pensions

No it doesn't. It you have yours set up correctly, it will reduce your CT bill. If you have yours set up incorrectly then it increases it by 25% as tax relief is 20%.

philrush

Hi,

Thanks for replying.

I mentioned self employed, as I employ no other people, the company is just me. You're quite correct I'm a company director rather than a sole trader.

Perhaps I have mine set up incorrectly. How would I pay for a personal pension from within the company? Is this the usual practice? How would this work in terms of lowering my CT bill?

Also when I said the government adds 20%, I'm referring to "the taxman usually tops up your payment with tax relief at 20%" quote from standard life website. I thought the idea was, I pay £100 in, the government adds £20 to the fund, am I wrong?

Also how do you get 25%? Isn't the tax I'm paying on my pension contribution paying out my personal account, CT @ 20% + 32.5% Div - 10% Div = 42.5%, so do you mean 22.5% or am I confused?

Thanks for your help I appreciate your advice.

Phil

zygurat789

When you say "the company" do you mean an limited company? That is the impression you give, in which case the company is a separate legal entity which employs you, you are an employee and pay PAYE and the company pays corporation tax not you.
The pension payment is an allowable expense in the company's tax computation and, therefore, reduces the amount of tax payable.
You pay £80 into a pension, the taxman adds £20 total £100.
The taxman adss 25% of what you pay which is 20% of the yotal payment

dunstonh

I mentioned self employed, as I employ no other people, the company is just me. You're quite correct I'm a company director rather than a sole trader.

In tax terms, self employed means paying class 2 & 4 NI.

Perhaps I have mine set up incorrectly. How would I pay for a personal pension from within the company? Is this the usual practice? How would this work in terms of lowering my CT bill?

For directors, it is the norm for you to pay the pension via the company. If you used an adviser, you should ask them why they did not do it this way. If you went DIY, then you need to really change it as it is inefficient the way you are doing it and could increase the amount of NI you will be pay.

philrush

Ok thanks will look into it. Looks like I've done this completely the wrong way.

What kind of pensions can you have via your company? I currently have one set up with Aviva, a stakeholder pension.

Best, Phil

dunstonh

What kind of pensions can you have via your company? I currently have one set up with Aviva, a stakeholder pension.

Virtually all of the ones you have on the retail market. Skakeholder pensions are largely obsolete nowadays (personal pensions tend to be cheaper as well as having greater investment choice). Nothing wrong with a stakeholder. Just not the best option for most people nowadays.

zygurat789

philrush wrote: »

Ok thanks will look into it. Looks like I've done this completely the wrong way.

What kind of pensions can you have via your company? I currently have one set up with Aviva, a stakeholder pension.

Best, Phil

Talk to Aviva.

Whilst we're here if you were to reduce your salary by £1,000 then you would not pay PAYE £200 NI £120 and the company would not pay £138.
You could then pay yourself an extra £1,000 dividend and pay how much tax and NI????

philrush

Hi,

Ok thanks, I'll speak to my accountant and pension provider. I've had a quick scan around on the internet it seems people are a bit divided whether it is best to go for personal contribution or company contribution for pensions. But most side on company.

Will levels of income affect which is the better option?

As I understand doing a pension via company will give me a saving on CT of 20% tax, but I will lose the tax man adding 20% to my personal contributions.

So on a lower income both ways of doing it would be identical.

But at the higher dividend rate I will be taxed a total of 42.5% on money before I can get it in to the pension, even with the 20% relief that's 22.5%

So that would suggest to me that the company route saves 2.5% at the higher dividend rate, as I would need to increase my contributions by 20% to match the taxman's relief via the personal route.

Have I got this right?

Also I am likely to switch to a personal pension or sipp, get some professional pension advice when I have more of a pension built up, say around 10k which I should have in a year. Is there a lower amount financial advisers will deal with, I think I read they won't touch most small investors? I was looking to do a DIY Sipp originally but found the whole thing too time consuming, so would prefer a professional to do it, when I have more funds built up.

Thanks, Phil

dunstonh

Ok thanks, I'll speak to my accountant and pension provider. I've had a quick scan around on the internet it seems people are a bit divided whether it is best to go for personal contribution or company contribution for pensions. But most side on company.

Shouldnt be any debate. However, that is the internet for you.

Will levels of income affect which is the better option?

Not really. Your accountant will want you to take just enough income to use your personal allowance and qualify for a state pension. The rest will be in dividends. The amount you can pay in to the pension yourself will be less than what the company will be able to pay in (subject to annual allowance cap).

As I understand doing a pension via company will give me a saving on CT of 20% tax, but I will lose the tax man adding 20% to my personal contributions.

Both give you 20% relief.

So on a lower income both ways of doing it would be identical.

You need to factor in NI.

Is there a lower amount financial advisers will deal with, I think I read they won't touch most small investors?

You wont be of interest to many IFAs but a fee based IFA can still come in cheaper than a nil commission DIY stakeholder. So, it is worth it. You tend to find smaller local firms are better on dealing with the smaller stuff. More rural tend to be as well.