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Pensions vs dividends?
Dividends are a traditional way of a director being paid from a company.
However, the tax advantages have been reduced in recent years, mostly through increased income tax rates on dividends.
This means that other payments can be more tax efficient. One of these methods is company pension contributions.
Benefits of using either Pension or Dividends
If you need to be paid from your company immediately, then dividends are good way to do just that.
However, your company can make contributions to registered pension schemes on your behalf and these contributions have greater tax benefits than dividends.
Dividends can only be paid by companies when they have made profits, if there is no profit, then you can’t be paid dividends. This is not the case with pension contributions, where the company can make them, even when making a loss.
There is a limit at which point dividends become more tax-efficient than pensions, and this is the £40,000 yearly pension contribution allowance. After this point, pension contributions attract extra tax.
If you haven’t used the annual allowance of £40,000 for the last three years, the company can make increased contributions to use up the missed allowance.
Examples
The example below shows the tax position for £10,000 taken out as dividends versus pension contributions which are then taken out late for a higher rate taxpayer.
Dividends:
Gross amount £10,000, taxable at 32.5%.
This is a tax bill of £3,250 leaving £6,750 in your pocket.
Pensions:
Gross amount £10,000, less than 25% pension tax-free amount of the gross figure, £2,500. This leaves a taxable amount of £7,500.
Less the tax rate of 40%, which is a tax bill of £3,000 and leaves a net income of £7,000
This is a personal tax saving of £250.
The company reduces its corporation tax liability by £1,900.
Dividends v Pension = Pension saves £2,150
What else do i need to know about Pension vs Dividends?
The main drawback with pension contributions is the fact that you will have to wait until you’re at least 55 to get the money. However, the significant tax savings could make it worth your while.
The reality is that you are more likely to combine dividends and pension contributions, as this will save tax in the long run, whilst giving you immediate income.
The precise savings you can make, and the best ratio of dividends to pension contributions will vary depending on your exact circumstances.
If you want to find out more about how pension contributions could help reduce your tax bill whilst planning for the future, contact the Tax Expert today on 01772 788200
Kind regards Ilyas