Are Director Pensions allowable in your business?

5th December 2022

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The principle of British companies providing their employees and workers with pension contributions is well established in the UK.

However, many advisers are not aware that the position of employees and company directors from a pension perspective, while sharing some common issues, is not necessarily identical. For example, whilst a company can choose to make pension contributions for a director, it is not obliged to.

Accountants will be aware of the general income tax restrictions that apply to pension contributions. While the precise rules differ depending upon whether someone is in a defined contribution (money purchase) scheme or a defined benefit (final salary or average salary) arrangement.

Key restrictions include:

  1. a maximum annual allowance of £40,000 per annum (or the level of the individuals’ earnings for a tax year, if they are under £40,000)
  2. contributions of £3,600 (including 20% tax relief), if someone has no other earnings or income for a tax year; and
  3. a pensions lifetime limit of £1.0731m.

The above restrictions do, however, potentially come with some easements. For example, it may be possible for company directors to have tax-effective pension contributions of more than £40,000 for a tax year if there are unutilised contributions from an earlier tax year.

If the contribution is made legitimately in the course of business and of a reasonable level given the business profits and work of the individual involved it should therefore be legitimately tax deductible from a corporate tax perspective. The fact that the contributions are above the headline annual pensions allowance figure of £40,000 per annum does not change the allowability from a corporate tax perspective.

Pension contributions to an employee or company director are innately not liable to employer NICs. As such, simply paying an employer contribution of say £60,000 per annum should not create any liability to employer or employee NICs.

For Corporation tax the question can involve an element of judgement. However, are the ‘total drawings’ from the business legitimate given the overall turnover of the business and the responsibilities of the individual(s) involved? In practice, if you are dealing with an only shareholder, owner-director situation, HMRC would usually accept that the drawings are reasonable, if the drawings are not damaging the future viability of the business. However, other factors they might consider as part of the overall reasonableness test include:

  1. Are there other senior employees of the company too? If so, what level of pension contributions does the company make for them? Are the contributions to the director(s) broadly in line with these employee contributions?
  2. What are the annual profits of the company? HMRC may challenge director pension contributions that exceed the core profits for a year.

While it is easy to focus on the tax issues, whether employment tax/income tax or corporate tax related, advisers should consider the wider position of the company when providing advice in this regard. For example, if the company is continuing to grow and needs to maintain a positive cash flow to fund this ongoing growth, it may be sensible for owner-directors to avoid making increased contributions into a pension scheme, as such pension contributions are then trapped in the scheme until the owner-director reaches retirement age. In contrast, funds taken from the business as dividends, for example, could potentially be loaned back to the business.

Director pensions can allow you to make some great tax savings especially when facing increasing rates of corporation tax and can therefore help you mitigate the tax increases and the impact on your overall takings from the company.

If you’d like to see how you can maximise your tax planning for your business then call Russell now:

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