Pensions & Tax: Understand what tax reliefs are available to you
As you establish as a business owner, you will need to be proactive with personal finances to keep yourself financially secure in case of any surprises that may limit your earning power, and of course, planning for the future. More often than not, business owners are aware that saving towards your pension is a good thing, but many are unaware of the detail behind the headlines and how the rules apply to them.
Did you know?
-
Pension tax reliefs are based on your income tax band? So the more you earn, the more tax relief you get on your pension contributions.
-
Pension contributions as a limited company director are not only advantageous for putting aside up to £60,000 per tax year tax-free, but you can also enjoy up to 26.5% reduction in corporation tax liability?
-
You can save up to £60,000 per tax year (6th April to 5th April) tax free into your pension.
-
The state pension is also available to you in addition to any other private pension schemes you make contributions.
-
The Lifetime Allowance or the amount you can invest into your pension in your lifetime without a tax charge was abolished from April 2024. This means pension pots can grow to any size without excess tax penalties being incurred.
Pension tax reliefs are based on your income tax band
You can pay any amount you want into a pension scheme. You could in theory invest your entire salary into your pension but any contributions you make above £60,000 in a tax year come with a tax charge.
The amount of tax relief you receive when paying into your pension depends on what income tax band you are. For example, if you are basic rate taxpayer in England, you pay 20% on your income up to £50,270 in the current tax year 2024/25. If you decide to contribute £100 a month into your pension, as a basic rate taxpayer you get 20% tax relief and your pension pot will receive the £100 but you only pay £80, or 80%.
If you are higher or additional rate taxpayer, as well as getting the 20% tax relief that is offered to basic rate taxpayers, you receive an additional 20% tax relief on the pension contributions you make. Employed or self employed, you would need to claim this additional 20% via your self assessment tax return.
When your income is over £240,000, there is a tapering on the annual £60,000 tax free allowance (known as the ‘annual allowance’), where it reduces by £1 for every £2 you earn above £240,000.
If you earn nothing at all in a tax year or you earn £3,600 or less, the maximum you can contribute to your pension is £2,880.
The pension tax perks as a limited company director
As a sole trader you can receive tax relief on your pension contributions when setting up a private pension scheme. How much tax relief you receive and how much you can invest tax-free is noted in the above section: ‘Pension tax reliefs are based on your income tax band.’
A director has additional perks when making pension contributions, namely the pension contributions are viewed as an allowable business expense, which in turn will reduce the limited company’s corporation tax liability. The corporation tax saving ranges from 19% to 26.5%.
You can also make pension contributions as a director before taking a salary or dividend from your company, so you pay less income tax and/or dividend tax when extracting profit from the business. In other words, you can make pension contributions based on the profit in the business, then pay tax on your salary/dividends only.
Pensions are one of your main tools for tax savings, will this change with a new government?
Although there are various tax rules and allowances to consider, making pension contributions is one of the best ways to save on your tax bill whilst investing in yourself. However, the wealthy receive enhanced tax reliefs on their contributions as do company directors, who enjoy both tax relief on their pension as well as corporation tax.
To make the system fairer, we would expect a change in the rules to equalise the tax reliefs for all, and in the current economic environment and the changing of the guard at No.10, this is a good a time as any to review your plan for retirement and make contributions now if you can in case of any changes to the tax reliefs with the next government.
The state pension: how much is it and is it taxable?
The state pension is an additional pension you could receive if you have been employed and self employed for 10 full years and up, and is funded by national insurance contributions (NICs).
The amount you receive in your state pension is reviewed annually. This is part of the system known as the ‘triple lock’. The triple lock is a commitment to increase the state pension annually based on the highest of 3 things: inflation figures, average increase in wages or 2.5%.
However, the state pension is taxable income. The current state pension is £221.20 per week as at April 2024, if you receive the full state pension, or worked or paid 35 full years of NICs. This is the below personal allowance threshold of £12,570, but if a pensioner has a private pension as well, this could mean that pensioners from this tax year onwards will need to complete a self assessment tax return and pay tax on income received over the personal allowance. The tax payment is easier to administer if you have employment income and state pension income; you still need to pay tax but the tax is collected via your tax code and collected monthly via your payslip versus the requirement to complete a self assessment tax return.
What is the lifetime allowance?
The Lifetime allowance (LTA) is the amount you can draw down (not make contributions) from your pension without incurring a tax liability. The LTA was abolished from April 2024, which means that currently you can save as much as you want into your pension without a tax penalty.
Previously, the LTA was set at £1,073,100. The LTA is a relatively new tax charge, and before 2006, it didn’t exist. When it was introduced, the limit was £1.5 million, then rose to £1.8 million by 2012 and then started to fall. It was abolished by the Chancellor in the Spring Budget 2023.
Whether the LTA is reintroduced or not by the next government is not clear but in the meantime you can ask your pension provider to give you an idea on how close you are to the latest LTA figure of £1,073,100 if you want to prepare for a potential LTA reinstatement.
Pensions later, protection now?
If you are on the start of your business journey and cash flow takes immediate priority, then you may want to invest in protection insurance and your consider making contributions to your pension at a later date. Protection insurance is an allowable business expense and can protect your income in case you cannot work for a period of time.
Please get in touch if you want to learn more.
