Question: My company will make a small profit this year and I was thinking of making a pension contribution to save tax. What is the best way to do this?
Answer: There are basically two ways you can go about making a pension investment, firstly you make it personally or secondly the company as your employer makes a contribution on your behalf.
If you make the contribution personally then you are effectively making the investment out of your net income which means you are eligible for additional tax relief.
Any contribution that an individual makes, is done so net of basic rate tax. What this means in practice is that for every £800 invested, the pension is automatically topped up by a further £200, which represents the addition of basic rate tax.
This is always given at source which avoids the individual having to claim the tax back.
If you are a higher rate tax payer, then you are eligible for some further tax relief but it is your own responsibility to claim this via your tax return.
So if all the pension investment attracted higher rate tax relief, then you can claim a further £200 back when you complete your self assessment form.
I say only if all the pension investment attracted higher rate relief, because if you make an investment and not all of it is eligible for further relief, then the amount of tax you get back will be reduced.
If you are intent on maximising your higher rate tax relief then you just need to ensure that your overall income (plus any other benefits in kind such as car etc) less the pension investment is above the basic rate tax threshold, which is approximately £40,000.
In terms of the maximum contribution you can make towards a pension, assuming you are not caught by the recent Budget changes that affect people earning in excess of £150,000, then you can contribute 100% of your relevant earnings.
The second option I mentioned is for you to make the investment via your company on your own behalf. Here the tax relief all falls back onto the company and in some respects is much simpler.
Any pension investment made by a company is eligible for Corporation Tax relief, and is simply treated as a normal business expense.
Therefore if the company is to make a pension investment on your behalf, it can then write off that investment fully against tax.
So if for example the company is on track to make a profit of £100,000 and decides to make a pension contribution of £10,000, then the amount it will pay tax on will be £90,000. So again depending upon the tax rate, the amount of tax that the company saves can be very attractive.
This is particularly beneficial for companies that make profits just in excess of £300,000, as any contribution will attract tax relief at the small company’s marginal rate.
The amount a company can pay into a pension on your behalf is also higher than that allowed personally. Again providing you are not deemed as a high earner, the company could invest up to £235,000.
More often than not, it is more tax efficient for your company, as opposed to you personally, to make the contribution as this will involve saving some National Insurance tax. It will also mean that you do not have to wait for any higher rate tax relief due on the investment.
As far as making a company contribution, the best time to do that is just before your year end, so if that is the end of June you better be quick!
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact: firstname.lastname@example.org or telephone: (028) 9022 1010