If you are the owner of a small or medium sized company chances are that your accountant has suggested you take a low salary and higher dividends…
But are you thinking about taking advantage of tax relief and making a large pension contribution?
If so, you probably know that in the current tax year (ending 5th April 2020) there is an annual pension contribution limit of £40,000.
This is known as the standard Annual Allowance.
If you want to pay a larger personal contribution into your pension scheme, you may be able to use unused allowances from up to three previous years. This is called Carry Forward.
If you receive a low salary and top up your income with dividends, maybe to keep your tax down, there is another limit you need to consider.
Your personal pension contributions are capped at the level of your net relevant earnings (NRE). These are your taxable earnings (such as salary less deductions) but don’t include dividends.
Any personal contribution will be limited to your net relevant earnings (NRE) which will probably be less than the Annual Allowance.
There might be another answer – can your company pay the pension contribution?
You see, Employer contributions aren’t limited by your net relevant earnings (NRE).
So can pay up to the annual allowance plus the carried forward unused allowance if required.
And, the pension contribution is usually a tax allowable deduction that you can claim against corporation tax.
NOTE: It’s also really important that you check that you qualify for the full standard Annual Allowance. That you’re not restricted by either the Tapered Annual Allowance (which could reduce your annual allowance to £10,000). Or the Money Purchase Annual Allowance (which reduces your maximum contribution to £4,000).
Here is an Example:
John is a director and shareholder of PlanA Ltd. He receives an annual salary of £12,000 plus dividends of £80,000 for the last 5 years. He has no other income, so qualifies for the standard annual allowance.
John’s been paying a small annual contribution of £1,200 on the 1 January each year into his personal pension over that time.
He now wants to use his pension fund to purchase a commercial property. Which means he needs to make a one off contribution of £100,000.
But all he can pay as a personal contribution is £10,800 (£12,000 – £1,200) because his salary is too low under the NRE limits to pay the larger contribution.
So instead his company pays and should receive corporation tax relief.
The rules allow him a total contribution of up to £155,200 in the current 2019/20 tax year (i.e paid on or before 5/4/2020)
His unused Annual Allowance for 2019/20 is £38,800.
Plus, he can carry forward unused allowances of £116,400 for the last 3 years:
2016/17: £40,000 – £1,200 = £38,800
2017/18: £40,000 – £1,200 = £38,800.
2018/19: £40,000 – £1,200 = £38,800.
Well within the £100,000 he needs for his property purchase investment.