Reply to: Pension Contibutions - Personal vs Comapany Contribution

[IR35 Avoider]

I have updated the spreadsheet to incorporate the latest corrections. Although you can't update it directly to try your own scenarios, I think you can save a copy to a local drive in Excel format. Even if you don't have Excel, other spreadsheets might be able to read the file. (One would hope a free Google documents account would, as that's where it's coming from.)

http://spreadsheets.google.com/ccc?k...gEGgLOX0wPZ0UQ

[IR35 Avoider]

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.

You posted this while I was composing my similar example.

Remember that one of the original conditions of the problem was that the amount ending up in the pension had to be the same either way. In other words, a £800 net contribution (subsidised from other income) should be made in your example.

The reason I say there is an advantage is because there is nothing in the tax return that links the treatment of the extra dividend income to the treatment of the extra pension contribution. The extra dividend income increases the amount taxed at the higher rate by £878, but a £800 net (£1000 gross) pension contribution decreases it by £1000. Assuming the difference of £122 is dividends on which extra higher-rate tax of 22.5% would have been paid, you save 22.5% * £122 = £28, but you had to make up the difference between £800 pension contribution and £790 dividend with £10 other money, so overall you are only £18 better off.

[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

[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]

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

[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 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.

[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 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 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.

[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!

[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.

[THEPUMA]

I challenge anyone to prove me wrong. Any examples in which gross salaries or total amounts ending up in the pension are not identical in both scenarios will be disqualified for not comparing like with like.

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

[minstrel]

We will have to agree to disagree on this topic. I don't have any hardcore evidence to suggest personal contributions are more tax efficient as I don't have time to create a working document to prove my case...

However, In my view, I am happy to go down the route of both as it would create certain benefits on both counts (with more benefit, currently, from the employer contributions...). As you don't believe making personal contributions are worth it, then I respect your opinion. However, my views make sense to me from both a corporate tax perspective and from a personal tax perspective. Depending on which benefits you wish to look at, one has to make the decision at what is best for the individual and for the company.

In the red corner we have IR35 Avoider who has made the case that company contributions are more tax efficient, spent some time doing calculations, prepared a worksheet to share his working and opened it up for peer review.

In the blue corner we have pmeswani who argues that making company and personal contributions is a good idea, but can't give any examples, has no hardcore evidence and doesn't have time to prove their case.

To be honest pmeswani, I think it's very poor form to get involved in a thread, cast doubt on what someone is saying and then not back it up.

Debate is good, and it's right to challenge or correct people when they are wrong. But as expat pointed out, this isn't a matter of opinion it's a matter of arithmetic.

If you don't have the time or ability to do the sums, don't get involved in an arithmetic debate. If you are saying their are other issues/risks that need to be taken into account other than the maths, then you should state what they are.

[pmeswani]

As I've said, it's highly unlikely to be most efficient to make any personal contributions. Either show me a worked example with figures where it is better to make personal contributions or accept that in the vast majority of situations it's better to make only company contributions and not a mixture of both.

We will have to agree to disagree on this topic. I don't have any hardcore evidence to suggest personal contributions are more tax efficient as I don't have time to create a working document to prove my case...

However, In my view, I am happy to go down the route of both as it would create certain benefits on both counts (with more benefit, currently, from the employer contributions...). As you don't believe making personal contributions are worth it, then I respect your opinion. However, my views make sense to me from both a corporate tax perspective and from a personal tax perspective. Depending on which benefits you wish to look at, one has to make the decision at what is best for the individual and for the company.