So they would need to set up their pension and pay into it via their bank account, and they can do so from their income.
If their income before tax takes into the higher tax income tax bracket, they will need to claim the extra back via their self-assessment tax return, if they are a basic-rate taxpayer any tax they pay will be claimed back through the pension provider and paid into their pension fund.
How a director of a limited company can pay into a pension
Self-employed workers who run their business through a limited company can pay into a pension in two ways:
- They can use the salary their limited company pays them, in the same as a sole trader (above).
- Direct, as an employer, so from company profits after corporation tax.
Paying into a pension as an employer offers an additional opportunity to mitigate tax as these payments are considered a business expense and can be offset against the company’s corporation tax bill.
Limited companies can also use pension contributions to offset their tax and the ‘carry forward’ rule allows them to backdate any of their unused annual allowance – £60,000 or a maximum of 100 per cent earnings if earnings are under £60,000 – over the previous three tax years.
How much tax can I save by contributing to my pension?
A company director of a limited company can pay up to £60,000 and get tax relief, so long as their earnings are £60,000 or over.
A sole trader or a company director being paid via PAYE through their company can also get tax relief at 20 per cent, 40 per cent or 45 per cent, depending on what they earn.
Paying directly into a pension as an employer can offset a corporation tax bill, this rose from 19 per cent to 25 per cent of income in the financial year April 2023 to April 2024.
Keeping an eye on self-employed pension clients
Moffat says changes in tax rules can mean what was the best option one year might not be the following year.
She says a reduction in the dividend allowance, dividend rates, income tax and employer and employee national insurance on salary means that the most tax-efficient way to extract money from a business is by paying into a pension.
“This is because employer pension contributions miss all the tax walls. However, paying it all into a pension is only a viable option if the business owner is over 55 and can access pensions.
"Most people need money now to deal with today’s expenses.”
How do dividends and pensions work?
If a director of a limited company takes their income as both salary and dividends, dividends are not considered relevant UK earnings and only income can be used to calculate any pension tax relief.
So a self-employed company director wanting to contribute more to their pension might be better either increasing their salary or paying the pension direct via the company.
Employers also do not have to pay national insurance on pension contributions, so this means they could save, but with all the changes to national insurance, it is worth making sure clients understand the impact of the January 6 national insurance reduction on their financial plan.
