As a business owner, making smart financial decisions is key to optimising your tax liabilities and securing your financial future.
One important choice is whether to take profits as dividends or income, or to make employer pension contributions. This decision can significantly impact your tax liabilities and long-term financial health. By understanding the advantages of making employer pension contributions, you can leverage benefits like tax relief, NIC savings, personal tax deferral, and tax-free growth.
Dive into our detailed case study of Jane’s Bakery Ltd. to see these benefits in action and understand how you can maximise your net distribution.
1.Tax relief on pension contributions
Employer pension contributions are tax-deductible expenses for your business. This means the amount you contribute to an employee’s pension, including your own if you’re a director, can be deducted from your company’s profits before corporation tax is applied. This reduces your overall taxable profit, leading to significant tax savings.
2. Avoiding National Insurance Contributions (NICs)
When you take profits as salary or bonuses, both you and your company have to pay National Insurance Contributions (NICs). However, employer pension contributions are exempt from NICs. This can result in substantial savings, especially for higher earners.
3. Deferring personal tax liabilities
Taking profits as dividends or salary means you pay personal income tax immediately. In contrast, pension contributions aren’t taxed until you withdraw the funds, typically at retirement. This deferral can be advantageous, especially if you expect to be in a lower tax bracket when you retire.
4. Tax-free growth
Pension funds grow in a tax-advantaged environment. Investment returns within the pension aren’t subject to capital gains tax or income tax, allowing your retirement savings to grow more efficiently compared to other investment vehicles.
Case study: Jane’s Bakery Ltd.
Background
Jane owns a small bakery, Jane’s Bakery Ltd., which has been profitable over the past few years. Jane is a higher rate tax payer and is considering how to best utilise her profits for long-term financial security. She has the option to take the profits as dividends or salary, or to make employer pension contributions.
Scenario:
Jane decides to distribute £20,000 of the company’s profits to herself.
Tax Implications for Jane
Note: For the pension contribution, 25% (£5,000) is tax-free, and the remaining 75% (£15,000) is taxed at 20%, resulting in £3,000 tax. Investment growth is ignored.
Tax Implications for Jane’s Bakery Ltd.
Comment
From the tables, it’s clear that making an employer pension contribution provides the highest net distribution for Jane, as it avoids immediate tax and NICs while also offering a corporation tax saving for Jane’s Bakery Ltd. This strategy not only maximises Jane’s current financial benefit but also enhances her long-term retirement savings.
Taking profits as dividends or income has its own benefits, such as having access to the cash immediately. Employer pension contributions, though, offer a range of tax advantages that can enhance your financial planning strategy. By reducing your corporation tax liability, avoiding NICs, deferring personal tax, and benefiting from tax-free growth, pension contributions can be a highly effective way to manage your business profits and secure your financial future.
How can we help?
Nathan Richardson is an Investment Director & Chartered Financial Planner in our expert Investment Management team.
For further financial advice concerning your investments or finances, please get in touch with Nathan or another member of the team in Derby, Leicester, or Nottingham on 0800 024 1976 or via our online form.
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