HR · 7 September 2017

Your business is not your pension, but it can build one for you

Your business can build your pension,  and here's how
Your business can build your pension, and here’s how
Your limited company can, literally, save a fortune into a personal pension for you, but too few business owners realise that a pension is still by far the most tax-efficient way to take money from their business, writes Tom Conner, director of Drewberry Wealth Management.

Like many clich’s, the notion of the otherwise successful business owner who just hasn’t “got to grips” with the pension regime, is still mostly true. Indeed, far too many still labour under the illusion that their business is, somehow, their pension.

Unfortunately, confusing the two is likely to be one of the most expensive mistakes that any small business owner can make. For one thing, it’s a gamble that, someday, a buyer will appear and pay top dollar for your life’s work namely a business that can continue on in your absence.

It also assumes that, once you’ve converted your business into a lump sum you can just sail off into the sunset without the need to put any of these assets into the pension regime even though retirement income will now be your primary concern.

Lastly, it also overlooks the fact that most assets you hold outside of a pension wrapper will be added to your estate for inheritance tax purposes and subject to a charge of 40 per cent on anything over the “nil-rate band” currently a puny 325, 000 when you die.

Limited understanding

As a business owner, when it comes to planning your retirement, you need to remember two things: the first is that the limited company you went to all the trouble of creating exists to deliver an income to its owners in the most tax-efficient way possible. The second is that, when it comes to tax efficiency, nothing has ever come close to a personal pension as a mechanism to take money out of the business you’ve built.

There are two potential approaches and what’s best for you will depend on the state of your company’s finances and, ultimately, how you choose to take your current level of remuneration from the business. However, both approaches are still miles ahead of pinning your retirement hopes on the future sale of your business.

Approach 1: Keeping it simple

The simple way to fund a pension is to pay contributions from your post-tax salary, which means that youll be paying National Insurance on your contributions. Like everyone else who funds a pension in this way, youll usually receive tax relief at your highest marginal rate on your contributions 20 per cent for basic-rate taxpayers and 40 per cent for higher-rate taxpayers so youll effectively reclaim the income tax you pay.

Meanwhile, your pension fund will continue to grow in the tax-free environment of a pension wrapper until it’s ultimately exhausted (or you are).

But there are two key drawbacks with this approach. The first is that while youll receive basic-rate tax relief of 20 per cent at source, if you’re a higher-rate taxpayer youll need to include your pension contributions in your tax return and reclaim the additional 20 per cent tax relief you’re due via HMRC. This is naturally an additional burden and, depending on when you file your tax return, it could take over a year to receive your tax rebate.

The more pressing concern is that, for business owners who choose to take their remuneration as a tax-efficient combination of a small salary and the remainder in dividends, the maximum they could contribute (that attracts tax relief) is usually limited to 100 per cent of their salary (dividends wouldnt count in this figure).

So, for a business owner who pays themselves the “Primary Threshold” for National Insurance, their annual pension allowance would usually be limited to just 8, 164 a year.

Approach 2: Your company pays your contributions

A far more attractive option, if possible, is to have your limited company make an employer contribution on your behalf. This has a number of immediate advantages.

The first is that your company can usually contribute up to 40, 000 a year (gross) to your pension regardless of your actual salary level and attract corporation tax relief (provided HMRC are satisfied that this contribution is wholly and exclusively for the purpose of trade).

Also, as the company pays a gross contribution, there’s no need to apply for any higher-rate tax relief you may be due via your self-assessment form. This makes it far easier to administer and means that all of your pension contribution arrives in your fund on day one.

If you’ve not made a pension contribution in the last few years, you can usually also make use of the carry forward? rules, which allow any unused allowance from the previous three years to also be utilised.

Smooth operators