This article shows that there is no exact rule of thumb and therefore the question must be answered on a case-by-case basis.

There are a number of questions which first must be given consideration including:

1. Does the taxpayer have sufficient ‘relevant earnings’ to validate tax relief on personal pension contributions?

‘Relevant earnings’ do not include dividend income so if an owner manager takes only a minimal salary and the rest of their income as dividends then a company contribution is likely to be required if the amount to be invested into the pension fund exceeds their salary amount.

2. Will the contributions be within the taxpayer’s annual allowance of £60,000 per annum (from April 2023), which is combined limit for employer and employee contributions?

There is the option to carry forward unused contributions from the previous three tax years, however there is also an abatement of the allowance where the taxpayer has net income exceeding £260,000 (increased from £240,000 for 2021-22).

3. Has the taxpayer taken financial advice to establish that additional contributions into their pension fund are likely to be needed to meet their expected retirement income requirements?

This article covers some of the tax considerations but advice from an independent financial advisor should be sought before taking any action.

4. Will declaring dividends to fund a personal contribution push the taxpayer into an income ‘bracket’ which the extending of the basic rate band will not offset?

For example, the band of income between £50,000 and £60,000 where a higher earner in a household must repay child benefit payments.

We have performed some calculations to see how the overall rates of tax relief compare between company and personal pension contributions for an owner-manager across different income bands.

We have assumed the owner manager takes a salary equal to the personal allowance plus the basic rate band each year (salary of £50,270 for 2023-24) and pays all post corporation tax profits out in dividends. The calculations ignore the impact of the £2,000 dividend nil rate band. We have also assumed the company will be liable to the main rate of corporation tax of 25%, which applies to all profits of £250,000 or more.

Our tax relief figures are shown as a percentage of the money added to the pension fund, taking into account any income or company tax savings plus any tax reclaimed by the pension provider.

Tax relief on personal contributions

As well as the pension fund claiming back the basic rate tax paid on personal pension contributions (at 20%), the taxpayer receives further tax relief via the extension of his or her basic rate tax band. In our examples this means the owner receives tax relief of a further 25% (i.e. 33.75% less 8.75%) if they are in the higher rate band, or 30.6% (39.35% less 8.75%) as an additional rate taxpayer.

Tax relief on company contributions

To calculate the tax relief on company contributions we need to consider both the corporation tax saved (at the main rate of 25%) and also any personal tax that would have been charged on the dividends foregone. There are three main dividend tax rates (i.e. 8.75%, 33.75% or 39.35%) for varying levels of income.

Illustration 1 – post-tax profits within higher rate band but total taxpayer income would be <£100,000.

If the taxpayer makes a personal pension contribution then the pension fund gets the benefit of the 20% ‘top up’ from the Government, and the individual gets an extension to the basic rate band, meaning that more dividends are taxed at 8.75% rather than 33.75%. This gives an overall rate of tax relief of 45%.

If, instead, the taxpayer agrees to forego some of the dividend and the company makes the contribution on the taxpayer’s behalf then the company saves corporation tax at 25% and there is an income tax saving of not taking the post corporation tax dividend in the higher rate band which would have meant an income tax charge of 33.75% x 75% = 25.3%, therefore an overall rate of relief on the contribution of 50.3%. There is a marginal tax saving of 5.3% of having a company pension contribution within this band of income.

Illustration 2 – post-tax profits within higher rate band and total taxpayer income would be between £100,000 and £125,140.

Between £100,000 and £125,140 of income, a taxpayer’s entitlement to the personal allowance of £12,570 for the current tax year is abated by £1 for every £2 of income. The net effect is that the marginal rate of income tax is normally around 20% higher within that income bracket.

If the taxpayer makes a personal contribution, then the pension benefits from the 20% ‘top up’ and the individual gets an extension to their basic rate band, meaning that more dividends are taxed at 8.75% rather than 53.75%. This gives an overall rate of tax relief of 65%.

If, instead, the taxpayer foregoes some dividends and the company makes the contribution then it saves corporation tax at 25% and there is also an income tax saving of not taking the post corporation tax dividend in the higher rate band (of 53.75% x 75% = 40.3%), therefore an overall rate of relief on the contribution of 65.3%. There is a marginal tax saving of 0.3% of making a company contribution within this band of income.

Illustration 3 – post-tax profits within higher rate band and total taxpayer income would be >£125,140.

This band is the same as Illustration 1 above – a 5.3% saving of having a company pension contribution.

Illustration 4 – post-tax profits within additional rate band (i.e. greater than £150k).

If the taxpayer makes a personal contribution, then the pension benefits from the 20% ‘top up’ and the individual gets an extended basic rate band, meaning more dividends are taxed at 8.75% rather than 39.35%. This gives an overall rate of tax relief of 50.6%.

If, instead, the taxpayer foregoes some dividends and the company makes the contribution then it saves corporation tax at 25% and there is an income tax saving of not taking the post corporation tax dividend in the higher rate band (of 39.35% x 75% = 29.5%), therefore an overall rate of relief on the contribution of 54.50%. There is a marginal tax saving of 3.9% of having a personal pension contribution within this band of income.

Summary

As illustrated above, the prevailing rule of thumb is that a company contribution will be more beneficial when the company is paying corporation tax at the main rate of 25%. It is however important to note that not all companies will be paying tax at the main rate. If profits are lower than £250,000, the company will be entitled to Marginal Small Companies Relief (MSCR) and will pay a lower effective rate of tax. In these circumstances, the marginal tax savings between a company or personal pension contribution will tighten.

A taxpayer with an alternative income mix may also have different overall tax relief to the rates shown above. If you have any queries or would like our assistance, then please contact us.

This is intended as a summary and overview of the tax situation and does not constitute financial advice and no action should be taken without first seeking professional advice specific to your circumstances.