There has been much discussion on the impact of the dividend tax on total tax bills and the incentive to incorporate.
What has been less widely examined is how the new regime affects marginal tax rates, and the knock-on effect this has on the tax relief given to pension contributions. This article will look at the tax relief available on pension contributions made from an OMB company, and how this compares to the relief given to the same taxpayer on personal contributions.
Our test case owner-manager
All our calculations will be performed for a business person operating via a limited company. The owner draws a salary equal to the personal allowance of £11,500, and pays all post-tax profits in dividends to themselves as 100% shareholder. He or she has the choice of making pension contributions either as an employer or as an individual. 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, the taxpayer receives further tax relief via the extension of his or her basic rate tax band. In our example this means the owner receives tax relief of a further 25% (i.e. 32.5% less 7.5%) if they are in the higher rate band, or 30.6% (38.1% less 7.5%) as an additional rate taxpayer. In addition, the income used to calculate any reduction in the personal allowance is also scaled back by the grossed-up value of their pension contribution.
The total tax relief available on personal pension contributions is shown below for various bands of profit and personal income.
Table 1: Tax savings from personal pension contributions, 2017/18
|Salary||Profit||Dividends||Tax relief (%)|
|£11,500||£41,358 or lower||£33,500 or lower||20%|
|£11,500||£41,359 - £109,259||£33,501 - £88,500||45%|
|£11,500||£109,260 - £137,654||£88,501 - £111,500||67.5%|
|£11,500||£137,655 - £170,987||£111,501 - £138,500||45%|
|£11,500||£170,988 or higher||£138,501 or higher||50.6%|
Tax relief on company contributions
To calculate the tax relief on company contributions we need to take into account both the corporation tax saved and also any personal tax that would have been charged on the dividends foregone. There are four dividend tax rates (i.e. 0%, 7.5%, 32.5% or 38.1%) for varying levels of income, and the reduction in dividend payments may also slow the scaling back of the personal allowance.
The table below shows the profit levels associated with these various bands, and the total tax relief the owner/manager will receive (corporation tax and income tax combined) from making a company pension contribution.
Table 2: Tax savings from company pension contributions, 2017/18
|Salary||Profit||Dividends||Tax relief (%)|
|£11,500||£6,172 or lower||£5,000 or lower||19%|
|£11,500||£6,173 - £41,358||£5,001 - £33,500||25.1%|
|£11,500||£41,359 - £109,259||£33,501 - £88,500||45.3%|
|£11,500||£109,260 - £137,654||£88,501 - £111,500||63.5%|
|£11,500||£137,655 - £170,987||£111,501 - £138,500||45.3%|
|£11,500||£170,988 or higher||£138,501 or higher||49.9%|
Personal versus company contributions compared
So, given the above figures, should the business owner make personal pension contributions or pay them from company funds? Table three below summarises the total tax relief available for both methods.
Table 3: Tax relief from personal and company pension contributions, 2017/18
|Profit level||Tax relief on personal contributions (%)||Tax relief on company contributions (%)||Difference|
|£6,172 or lower||20%||19%||-1.0%|
|£6,173 - £41,358||20%||25.1%||+5.1%|
|£41,359 - £109,259||45%||45.3%||+0.3%|
|£109,260 - £137,654||67.5%||63.5%||-4.0%|
|£137,655 - £170,987||45%||45.3%||+0.3%|
|£170,988 or higher||50.6%||49.9%||-0.7%|
So there are some significant differences between the two methods. Company contributions are typically the best at lower profit levels, and the advantage peaks (at 5.1%) in the area where the taxpayer has a marginal income tax rate of 7.5%. However there are other areas where a personal contribution gives more bang for their buck, with the maximum difference (4%) in the profit band where any change to personal income affects the personal allowance available.
Before making a pension contribution, owner managers should consider the most tax efficient way of doing so given their profit level. Owners may also need to consider non-tax factors, such as cash flow considerations, maximising income for upcoming mortgage applications or whether their current pension provider accepts employer contributions. But, for many profit levels, making contributions direct from OMB companies now makes a lot of sense.
About Matt Bailey
Founder of Azura Cloud Systems (Gbooks), the leading cloud-based tax and accounts system.