Contractors' Questions: Should I build a nest egg personally or via my company?
Contractor’s Question: In financial terms, which is going to be more beneficial to me? To pay pensions contributions through my limited company (in order to reduce corporation tax) - or personally as I’m currently doing (to benefit from the government’s relief/contribution)?
Expert’s Answer: If investing personally, from your own bank account, then contributions are made net of basic rate tax, so that every £100 investment requires you to only contribute £80 at outset. You will then claim any additional higher rate income tax relief via your self-assessment tax return. You can invest up to 100% of the level of your salary (N.B. not dividends), but as most of our clients will pay themselves a relatively low salary this is ultimately going to restrict how fully you can exploit the valuable tax breaks associated with pension investment.
If you instead invest via your limited company then the contribution is made gross and is diverted (free of income tax or benefit in kind) straight from your corporate account into the pension. You offset these contributions as a business expense and therefore reduce your corporation tax bill (20% relief).
It could be argued that any higher rate tax relief is marginally better on a personally funded pension than a company funded contributions but in reality, the difference is negligible. If your company contribution avoids you having to draw a larger dividend, which would have pushed you into the higher rate income tax band, this effectively gains you the relief (i.e. you pay no additional tax in the first place so there’s nothing to claim back).
Crucially, the salary that you draw has almost no bearing on what can be invested by your company and so you should have far greater scope to invest, given that the only limit on contributions being a lifetime allowance of £1.5 million and the annual pension allowance of £50,000 (note, in certain circumstances, contractors can use the three previous years £50,000 allowances too).
Somewhat separately, IR35 is very much in the news again and it’s also important to remember that any company pension contribution is deemed to be allowable over and above the 5% expenses cap. In this way the blow of any subsequent IR35-related tax bill can be softened by company pension contributions that you make, whereas you would have suffered both employers’ and employees’ NI on a personal contribution that cannot be reclaimed.
The expert was Tony Harris, managing director of ContractorMoney, a specialist IFA for contractors and the self-employed.