While your client got their business off the ground they neglected their pension savings. They want to make up for it now, but you think that the annual contribution limits will prevent this. Is there a solution?
HMRC's rules and limits on pension contributions are often misunderstood. You'll know about the pension "annual allowance" (AA) which limits tax relief for contributions. Contrary to popular belief, it doesn't limit how much you can pay into a pension only the tax relief you'll get. In fact, there can be a tax advantage to paying amounts greater than the AA, but that's a story for another day.
There's a more obvious issue if your client wants to make a large pension contribution, especially if they're a company owner manager who takes a small salary topped up with dividends.
The overlooked rule
Personal contributions to a registered pension scheme are limited to your client's net relevant earnings (NRE). The NRE is the total of their taxable earnings, e.g. salary, benefits in kind, less tax deductible expenses, some tax reliefs and gift aid payments. This means even where the contributions they want to pay are less than the AA (plus unused AA for the previous three years), the amount which can be contributed is capped.
Example. Mary owns and manages Acom Ltd. For maximum tax and NI efficiency she intends to take a salary of just £8,500 in total for 2019/20. She has no other earnings or relevant outgoings and so her NRE figure is £8,500. She is not entitled to pay more than this into a registered pension scheme.
Tax efficiency conundrum
Despite Mary having stacks of AA going unused her low salary prevents her from building up her pension fund. One solution is for her to take more slary to hire her NRE. The trouble is this defeats the tax and NI savings she gets by adopting the "low salary plus dividends" strategy. The good news is there's another solution which is equally tax and NI efficient.
Tip. Instead of a personal contribution to her pension plan Mary can arrange for her company to pay an employers' contribution. Most personal pension plans will accept employers' contributions. If not your client can ask their pension company to amend the terms to allow them or a new pension plan can be started that does accept them.
Employer pension contributions aren't affected by the NRE limit. Plus, unlike other situations where the company pays for goods or services, it doesn't count as a taxable benefit in kind. This means there are no negative tax consequences for your client and no NI for their company to pay.
Your client's company can claim a corporation tax deduction for the pension contribution. Even where the contributions are large HMRC won't challenge deductions. The only caveat to this is where the company's contribution is large, in which case the tax deductions may be spread over a few years.