Whilst there is no absolute limit on the amount you can save in pensions, allowances are defined annually and over your lifetime, dictating when your pension becomes taxable. In recent years these allowances have become severely restricted:
- In 2010/11 the lifetime allowance was £1.8 million
- Today, in 2018/19, the lifetime allowance is £1.03 million
- In 2010/11 the annual allowance was £255,000
- Incredibly, today the annual allowance is capped at £40,000 (16% of the 2010/11 limit) and tax relief is only available on employee contributions up to the equivalent of your ‘relevant’ UK earnings that year
With the Government trying to actively encourage retirement saving with initiatives such as Pension Freedoms and auto enrolment, don’t these restrictions seem counterproductive?
For higher earners annual allowance is further restricted; anyone earning an ‘adjusted’ income of over £150,000 and a ‘threshold’ income of over £110,000 will be subject to tapered allowance restrictions. For every £2 of income over £150,000 their annual allowance will be reduced by £1. The reduction itself is capped to £30,000, so anyone earning an adjusted income of £210,000 or more can only save £10,000 tax free in pensions a year. The definition of ‘adjusted’ and ‘threshold’ incomes are a little complex and could justify an article of their own, if you think this may affect you, get in touch.
It is important to define ‘relevant’ UK earnings for maximum employee contributions; relevant income typically includes salary and bonuses, it doesn’t include pension or investment income. Significantly for business owners, it doesn’t include dividend income. When you consider most limited company directors split their renumeration between personal allowance salary and dividends to minimise tax, this would severely limit their employee pension contribution to £11,850. Therefore, as a director you have two options:
- Increase your salary (and income tax liability)
- Increase your employer pension contributions
Use employer’s contributions
Why? Employer contributions are not restricted by the relevant earnings cap. This means that you can utilise your whole £40,000 annual allowance.
Also, as employer contributions are paid gross, corporation tax relief is granted. HMRC state that employer contributions only qualify for relief if they are ‘wholly and exclusively’ for the purpose of business, which is a little vague, but legitimate pension contributions won’t raise eyebrows if your total remuneration is at a commercially reasonable level.
A very important point; to absolutely maximise your contributions you can carry forward any unused annual allowance from the previous three years, if you were a member of a registered pension scheme at the time. For example, if you had only paid £10,000 employer contributions each year between 2015/16 and 2017/18, using carry forward you could have a £130,000 allowance in 2018/19. Considering previously witnessed restrictions to the annual allowance, it would be prudent to make the most of this rule whilst it exists.
Naturally, the main benefit in taking full advantage of pension allowances is potentially increased income in retirement. However, as a director, there are other incentives;
- Employer contributions are an allowable business expense that can be offset against corporation tax. You also don’t pay National Insurance.
- Thanks to Pensions Freedoms, access to your pension fund is now unrestricted post age 55
- Upon your death pensions are usually free from inheritance tax
- Should the business unfortunately fail, pensions are protected from creditors
- SIPP and SSAS arrangements can be used to fund the purchase of commercial property
- SSAS permit a secured loan back to you as the employer, which can be used to fund business activities and assets beyond the purchase of property
The level you can contribute to pensions free of tax has been heavily restricted in the last eight years. You currently have an opportunity to maximise pension savings, mitigate tax and gain real benefits for you and your business. As time has shown, this legislation is prone to change; now is the time to act. For more information, contact us on 0800 612 8099 or request a call back by clicking here.