Pension Contibutions - Personal vs Comapany Contribution

[minstrel]

I can't ignore a challenge like that. I haven't thought of one yet but a pound says I can think of a really obscure scenario in which personal contributions are better.

PUMA

I think we've got 2 already:

Example 1

If revenue is really low, then it is better to pay personal allowance as salary rather than company pension and no salary.

For example, if company revenue is only £4k its better to pay £4k as salary, make a personal pension contribution of £4k and end up with £5k (after 20% credit) in pension.

If company paid the £4k direct to pension you wouldn't get the tax credit so only £4k would be in the pension.

Example 2

If you've got income (unrelated to the ltd co) in that tax year that you are paying 40% tax on, it might also be better to make a personal contribution.

[IR35 Avoider]

I can't ignore a challenge like that. I haven't thought of one yet but a pound says I can think of a really obscure scenario in which personal contributions are better.

PUMA

I may be losing my marbles, but I've made a couple of corrections to my spreadsheet, and I now believe pmeswani is right. I think the particular case is for people who are 40% taxpayers.

When you reduce the employer pension contribution and increase dividends correspondingly, you lose money because the net personal contribution you have to make is greater than the increase in dividend, but you gain more money through your 40% tax threshold being raised.

My excuse for not being aware of this case (if I have now got it right) is that I always try to ensure that I'm not a 40% taxpayer!

[pmeswani]

I may be losing my marbles, but I've made a couple of corrections to my spreadsheet, and I now believe pmeswani is right. I think the particular case is for people who are 40% taxpayers as a result of dividends.

When you reduce the employer pension contribution and increase dividends correspondingly, you lose money because the net personal contribution you have to make is greater than the increase in dividend, but you gain more money through your 40% tax threshold being raised.

My excuse for not being aware of this case (if I have now got it right) is that I always try to ensure that I'm not a 40% taxpayer!

There is another argument to be considered. When you pay yourself (as an employee and shareholder) you are already saving the company 21% in corporation tax. By making personal contributions you would be saving a further 20% in tax (or 40% for higher tax earners). Therefore making a 41% (or 61% for higher tax payers) in tax in general (please note I said in general here... not making the difference between Corp and personal tax). A play on numbers... maybe... but it is dependant on personal opinion and attitude towards tax. The only reason why I didn't show a detailed spreadsheet is that I was hoping that it would be a no-brainer.

My Accountant has recommended that I should only make employer contributions based on tax alone. I cannot see how (based on my lateral thinking) how not making the two-tier contribution is not a good idea... but my long term goal is to bolster my pension pot much as possible so that I can have a chunkier tax-free lump-sum and regular payments for when I retire.

[Lewis]

I may be losing my marbles, but I've made a couple of corrections to my spreadsheet, and I now believe pmeswani is right. I think the particular case is for people who are 40% taxpayers.

When you reduce the employer pension contribution and increase dividends correspondingly, you lose money because the net personal contribution you have to make is greater than the increase in dividend, but you gain more money through your 40% tax threshold being raised.

My excuse for not being aware of this case (if I have now got it right) is that I always try to ensure that I'm not a 40% taxpayer!

I disagree (I think ... quick calcs below, they may be wrong!)

If a company makes £1000. If you pay into the pension direct from the company, the pension amount will be £1000 and no corporation tax is payable.
Taking the money as a dividend instead and then paying into your pension would work as follows:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Assuming basic rate tax and all paid into pension
Pension + Tax relief = £790 @ 20% = 790/0.80 = £987.5

So you are worse off. If you are a 40% tax payer:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Tax paid on dividend = £877.78 * 0.225 (32.5% - 10% tax credit) = £197.50
That leaves £595 to pay into the pension
Pension + Tax relief = £595 @ 22.5% = 595/0.775 = £767.74

So you are even worse off.

[pmeswani]

I disagree (I think ... quick calcs below, they may be wrong!)

If a company makes £1000. If you pay into the pension direct from the company, the pension amount will be £1000 and no corporation tax is payable.
Taking the money as a dividend instead and then paying into your pension would work as follows:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Assuming basic rate tax and all paid into pension
Pension + Tax relief = £790 @ 20% = 790/0.80 = £987.5

So you are worse off. If you are a 40% tax payer:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Tax paid on dividend = £877.78 * 0.225 (32.5% - 10% tax credit) = £197.50
That leaves £595 to pay into the pension
Pension + Tax relief = £595 @ 22.5% = 595/0.775 = £767.74

So you are even worse off.

I am going to show my naivity / ignorance now. Why would I lose £210 if I pay myself £1k in dividends?

[Lewis]

I am going to show my naivity / ignorance now. Why would I lose £210 if I pay myself £1k in dividends?

If the company has £1000 profit you must pay corporation tax on that so that leaves you free to only take £1000-£210 as a dividend.

[IR35 Avoider]

There is another argument to be considered. When you pay yourself (as an employee and shareholder) you are already saving the company 21% in corporation tax. By making personal contributions you would be saving a further 20% in tax (or 40% for higher tax earners). Therefore making a 41% (or 61% for higher tax payers) in tax in general (please note I said in general here... not making the difference between Corp and personal tax). A play on numbers... maybe... but it is dependant on personal opinion and attitude towards tax. The only reason why I didn't show a detailed spreadsheet is that I was hoping that it would be a no-brainer.

My Accountant has recommended that I should only make employer contributions based on tax alone. I cannot see how (based on my lateral thinking) how not making the two-tier contribution is not a good idea... but my long term goal is to bolster my pension pot much as possible so that I can have a chunkier tax-free lump-sum and regular payments for when I retire.

Your argument is not correct. Here is where the extra relief comes from.

Suppose you are already a higher-rate tax payer, and you receive £1000 extra company income. If you make an employer contribution of £1000, your total pension contributions are increased by £1000 and neither you nor the company pay tax on the £1000.

If you decide to pay a dividend, the dividend will be £790 and corporation tax £210. To end up with £1000 extra in your pension, you will have to make a £800 personal contribution. So far, your are £10 worse off. However the £790 net dividend is regarded as a £878 gross increase in your personal taxable income, but your higher rate tax threshold is increased by £1000 as a result of the personal contribution. Therefore the amount you pay higher-rate tax on is reduced by £122. Since you pay 20% extra tax on higher-rate income, this saves you 20% of £122 which is £24. Take away the £10 you lost earlier, and your overall benefit is £14.

Note that this only works if you are a higher-rate taxpayer. If you are not, then you are never better off making personal contributions. (Not even when company income is very low, as I thought earlier.)

Don't forget that personal contributions do not immunise that income against IR35, employer ones do.

Edit: having seen the contribution by Lewis, I'm reminded that higher-rate tax on dividends is 22.5%, so the saving is 22.5%*£122-£10 = £18.

[Lewis]

I disagree (I think ... quick calcs below, they may be wrong!)

If a company makes £1000. If you pay into the pension direct from the company, the pension amount will be £1000 and no corporation tax is payable.
Taking the money as a dividend instead and then paying into your pension would work as follows:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Assuming basic rate tax and all paid into pension
Pension + Tax relief = £790 @ 20% = 790/0.80 = £987.5

So you are worse off. If you are a 40% tax payer:

2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
Tax paid on dividend = £877.78 * 0.225 (32.5% - 10% tax credit) = £197.50
That leaves £595 to pay into the pension
Pension + Tax relief = £595 @ 22.5% = 595/0.775 = £767.74

So you are even worse off.

I am sure the 40% calcs are wrong but I can't quite get my head around them at the moment ... any accountants out there? I am thinking that it doesn't actually matter if you are a higher rate tax payer or not. i.e. that it goes something like ....


2008/9 Corporation tax @ 21% = £210
Allows £790 dividend to be paid (£877.78 gross dividend, i.e 790/0.9)
You pay the £790 into your pension so
Tax relief + pension = £790 @ 20% = 790/0.80 = £987.5
No 32.5% tax to pay on dividend so end result is same as when on lower rate
Your 40% bracket may have shifted but that doesn't affect the amount you get in your pension or your pocket so doesn't matter

[moorfield]

What with CT held, and Income Shifting held, I am minded now to suspend pension contributions for a few years and keep the cash building in ltdco until I can get larger rebates against the inevitable rises coming along in future.

If you believe the Great Crash / Japan theory then equities are fooked now for 10 years anyway.

[Lewis]

What with CT held, and Income Shifting held, I am minded now to suspend pension contributions for a few years and keep the cash building in ltdco until I can get larger rebates against the inevitable rises coming along in future.

If you believe the Great Crash / Japan theory then equities are fooked now for 10 years anyway.

I don't disagree, some other considerations are :

- money put into pension now is when shares are low so good value
- if you have 10+ years to retirement then you have time for pension to recover
- money in company account is money that could get taken via IR35