How do personal pension contributions affect dividend tax?

RemotecUK

How do personal pension contributions affect your tax situation when you pay yourself via dividends?

For example:
Dividends received: £37,700 and let's assume for now no other income.

A dividend of £500, means that tax is due on £37,200.
(£37,700 - £500 =£37,200)

Dividend tax on 8.75% on this amount means that tax £3,255 is due to be paid.
(£37,200 * 0.0875 = £3,224)

Take home pay: £34,445
(£37,200 - £3,255 = £34,445)

If we now assume I paid from that income into a SIPP an amount of £10,000, where does that factor in to the calculation?

Does it act on the initial £37,700 and reduce it to £27,700?

This would reduce the taxes to £2,380 applying the calculations above.

HappyHarry

No - pension contributions do not work like that for dividends.

Dividends are not counted as earned income when considering pension contributions, so without additional earned income you wouldn't want to add £10,000 to a SIPP else you will face an additional tax bill.

Do you own the company from which you are receiving dividends? If so, you could make a company contribution of £10,000 to your SIPP instead of paying some dividends and potentially save on corporation tax.

RemotecUK

Thanks and that is what I had assumed.

Yes it could be possible to pay from an company.

I guess however, that if the company paid a combination of PAYE and dividends you could make contributions up to the PAYE received and offset that.

But this is complex in comparison to making a SIPP contribution from the Ltd.

Dazed_and_C0nfused

RemotecUK said:

How do personal pension contributions affect your tax situation when you pay yourself via dividends?

For example:
Dividends received: £37,700 and let's assume for now no other income.

A dividend of £500, means that tax is due on £37,200.
(£37,700 - £500 =£37,200)

Dividend tax on 8.75% on this amount means that tax £3,255 is due to be paid.
(£37,200 * 0.0875 = £3,224)

Take home pay: £34,445
(£37,200 - £3,255 = £34,445)

If we now assume I paid from that income into a SIPP an amount of £10,000, where does that factor in to the calculation?

Does it act on the initial £37,700 and reduce it to £27,700?

This would reduce the taxes to £2,380 applying the calculations above.

You have forgotten the Personal Allowance.

And you cannot deduct £500 like you have, all dividends are taxable and will either use some Personal Allowance or be taxed.

Let's say you have not applied for Marriage Allowance.  And are not Scottish resident.  Then you would be taxed like this,

The first £12,570 of the dividends are covered by the Personal Allowance.

This leaves £25,130 of the dividends to be taxed.

£500 x 0% (dividend nil rate) = £0
£24,630 x 8.75% (dividend basic rate) = £2,155.12

Total tax payable £2,155.12

Pension contributions would have no impact whatsoever on this.  With no earnings relevant for pension contribution purposes you would only be eligible to pay £3,600 gross into a pension (£2,880 you pay plus £720 in basic rate pension tax relief the pension company would add).

Dazed_and_C0nfused

RemotecUK said:

Thanks and that is what I had assumed.

Yes it could be possible to pay from an company.

I guess however, that if the company paid a combination of PAYE and dividends you could make contributions up to the PAYE received and offset that.

But this is complex in comparison to making a SIPP contribution from the Ltd.

I'm not sure what you mean by "offset that" but personal contributions you make don't reduce your taxable income.  So unless you are a higher rate payer (or intermediate rate payer if Scottish resident) then there is usually no personal tax savings from paying into a pension.

Grumpy_chap

RemotecUK said:

How do personal pension contributions affect your tax situation when you pay yourself via dividends?

For example:
Dividends received: £37,700 and let's assume for now no other income.

A dividend of £500, means that tax is due on £37,200.
(£37,700 - £500 =£37,200)

Dividend tax on 8.75% on this amount means that tax £3,255 is due to be paid.
(£37,200 * 0.0875 = £3,224)

Take home pay: £34,445
(£37,200 - £3,255 = £34,445)

If we now assume I paid from that income into a SIPP an amount of £10,000, where does that factor in to the calculation?

Does it act on the initial £37,700 and reduce it to £27,700?

This would reduce the taxes to £2,380 applying the calculations above.

It sounds like you have your own Ltd Co. of which you are Owner and Director.

If that is correct, the most tax efficient way to make pension contributions is as employer contributions paid direct from the Ltd Co. bank account.  This means that the pension contributions can be made without incurring any liability for Corporation Tax, Income Tax or National Insurance.

If you are only drawing dividends then these are not qualifying earnings and will not attract tax relief:
https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100#qualifying
You would be limited to pension contributions of £2,880 (£3,600 gross).  Contributions in this way do not reduce income tax liability within the tax year, but the tax relief "grossing up" is added to the pension fund from the nett contribution.

I note there is a stated assumption in the question.  For full advice, you may need to provide more information on the full manner of income received.  It is common to pay at least some salary sufficient to accrue qualifying years for NI.

The comments above relate to my understanding of the current rules.  Rules may be changed at any time by the Government of the day - most commonly as matters within the Budget.  The next Budget is in a couple of weeks' time.

RemotecUK

Thanks all for the information.