As a company director, you’re probably familiar with the balancing act of running a business while planning for a financially secure future. One of the best ways to achieve this is through tax-efficient pension contributions, which can benefit both your business and personal finances. Knowing when and how much to contribute each year is essential, especially if you want to make the most out of your company’s profits.
In this blog, we’ll be talking you through how you can maximise your pension contributions for tax efficiency, the benefits of timing those contributions well, and why the last quarter of the financial year might be the perfect time to make additional contributions.
The tax benefits of pension contributions
Pre-tax contributions: How they work for company directors
When you make pension contributions as a company director, you’re in a unique position to contribute pre-tax money directly from your company’s profits. This means that any contributions you make to your pension are deducted from your profits before tax is applied, resulting in considerable tax savings.
For example, if you run a small, limited company, you may be taxed at the corporation tax rate (25% for most companies from April 2023). However, any amount you allocate to your pension reduces the profit figure on which this tax is based, which means a lower tax bill and more money saved in the business.
Pensions as a “tax-free” expense
When contributions go straight into your pension, they aren’t taxed at either the corporate or personal level. This makes pension contributions one of the most efficient ways to direct profits into your future financial security without reducing your take-home pay.
Rate banding and efficiency
Another advantage is that pension contributions can help with rate banding. By making contributions, you can reduce your taxable profit enough to keep your company in a lower tax band, which could save even more money. If you’re nearing a higher tax rate, modest contributions could keep your tax bill more manageable. As tax rates increase, this approach is becoming even more valuable for directors and business owners.
Timing is key: The benefits of the last quarter
Assessing your company’s profitability
The timing of your pension contributions can be just as important as the amount you’re contributing. Generally, the best time to make additional, lump-sum contributions to your pension is in the last quarter of your company’s financial year. By then, you’ll have a clearer view of your year’s profitability, making it easier to decide how much to contribute without affecting the company’s cash flow.
Why the last quarter?
At the beginning of the financial year, cash flow can be unpredictable, and it’s hard to know exactly what your profits, client payments, or expenses will look like. Waiting until the last quarter gives you a nearly complete financial picture, making it easier to contribute the right amount with less risk.
This timing also works well if you’ve received a bonus or dividend, which you can add to your pension as a lump sum. This approach can help you grow your pension pot quickly, especially if it becomes a yearly habit at the end of each financial year.
Understanding contribution limits and lifetime allowance
Annual allowance for pension contributions
Each tax year, there’s an annual allowance for tax-relieved pension contributions — £60,000 per person as of 2023. If you exceed this limit, you might face additional tax charges. However, there’s flexibility here: you can carry forward unused allowances from the past three years, which is helpful if you didn’t maximise your contributions previously.
Lifetime allowance considerations
The Lifetime Allowance on pensions was recently removed in the UK, which means there’s no limit on the total tax-free amount you can save in your pension pot. However, it’s always worth keeping an eye on policy changes. Although there’s currently no restriction, there’s a chance the Lifetime Allowance could return, so larger one-off contributions may require careful planning.
Need some extra help managing pension contributions, tax or any other aspect of your business finances? Talk to our friendly team today, we’d love to help!
