I am a director of my own limited company. Currently I take a salary up to my personal allowance, and receive the rest of my remuneration as dividends.

I have heard that through carry forward I can pay in an employer’s pension contribution up to £180,000 gross. But that this may be limited by the company’s anticipated profits in the tax year, if they are going to be less than £180,000.

Could you clear up the confusion?

Andy

Rachel Vahey, 

AJ Bell Head of Public Policy, says:

How much can I pay into a pension should be an easy question to answer but often it gets confusing when thinking about the different types of contributions that can be made and the allowances that apply.

Employer contributions can be paid into a pension. To receive corporate tax relief the pension contribution has to be ‘wholly and exclusively’ for the purposes of the business. Basically, this means the contribution should be at a reasonable level for the individual concerned.  The local inspector of taxes will make the call on whether the employer contribution is reasonable.

CONTRIBUTIONS CAN BE MADE BY AN INDIVIDUAL OR THIRD PARTY

Contributions can also be made by the individual or another third party, for example a spouse or a grandparent. The value of these individual contributions plus the 20% tax relief paid by HMRC into the pension cannot be more than 100 per cent of the individual’s earnings each year. If they are then the excess will have to be refunded back to the individual.

Earnings generally include salary from employment or profits from self-employment, but don’t include any investment income such as dividends. Therefore, anyone earning a salary of £12,570 could pay in a net contribution of £10,056, HMRC adds 20% tax relief, and that brings the total contribution to £12,570.

Even if an individual doesn’t have any earnings, they (or others) can still pay in up to £3,600 a year to a pension – that’s £2,880 individual contribution, with HMRC adding £720. 

There are a few allowances on top of that. The annual allowance is set at £60,000 a year and includes both employer and individual contributions. For example, an individual could pay £40,000, HMRC adds £10,000 tax relief, and their employer could then pay in another £10,000, making £60,000 overall. (But that contribution would only be allowed if the individual earned at least £50,000.)

Any contributions over the annual allowance will suffer a tax charge at the individual’s marginal rate of tax, to put them back into the correct tax position.

TWO OTHER ANNUAL ALLOWANCES

There are two other annual allowances. One is the money purchase annual allowance which is set at £10,000, and is triggered if the individual ‘flexibly accesses’ their pension, say by taking an income through drawdown. The other is the tapered annual allowance which applies to very high earners. The taper can reduce the £60,000 annual allowance to as little as £10,000, depending on the individual’s income level.

If someone has not used up their annual allowance from the previous three tax years, then they can carry forward any unused annual allowance into the current tax year. They have to use up the annual allowance from the current year first, but could then go back and use up the annual allowance from the previous tax years, using the oldest year’s first. They don’t need to have made any contributions to the pension (they just need to have had a pension). If someone had not made any contributions over that whole period then they could have a total annual allowance of £200,000. (That is made up of £60,000 annual allowance from this year and last year as well as £40,000 from the two previous tax years.)

This sounds a very good opportunity in theory. A company director who had no pension contributions could receive a very big employer contribution. However, whether that employer contribution would receive tax relief or not would depend upon whether the local inspector of taxes judged that it met the ‘wholly and exclusively’ rule.

If the contribution was a personal one from the individual, then they could only pay in up to their earnings.  If someone wanted to pay a big employer contribution, then a conversation with the company’s accountant would be a good starting point.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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