Ways you can get paid from your company – Part 3 Pensions

This video talks about using pensions to extract money from your limited company. There are pro’s and cons, so it’s important to be able to weigh things up before making a decision.

And in today’s video, I just want to talk about our six-part series that I’ve been doing about ways you can get paid from your company. And what I’ve decided to go ahead is for the first breakdown video, I’ve decided to skip straight to part three, because I got asked a really good question yesterday, and I want to answer that question via this video, and then I’ll go back to part one and two in a future video.

So if you were watching my six ways you can get paid from your company video, then… By the way, actually I did think of a seventh way, but I hadn’t considered it as part of the six-part series because it’s part of selling your business, but keep an eye out for that anyway, because I will talk about the seventh way in the future as well.

But what I’m going to do is today I’m going to focus on pensions. Yesterday we talked about salaries, we talked about dividends and all the other things you could do to get money out of your business. So today we’ll have a look into pensions. We’ll talk about why they’re tax efficient. We’ll talk about the pros and cons. And we’ll also talk about some of the restrictions around contributing into a pension as well. So, let’s get straight into it.

Okay. In terms of getting paid from your business, a pension in a way is actually probably not a payment unless you can access it straightaway. So what I mean by that is fine, the pension is a great way to get money out of your business, but because it’s locked away in a pension, it means you don’t necessarily have access to it straightaway. How the rules in the UK work are essentially you’ve got access to your pension once you’re 55 years old. What that means is if you’re already 52 and you start putting money into a pension, you could get access to it in three years’ time. But if you’re like 20 years old and you start putting money into a pension, you’re just going to have to wait 35 years.

And actually, if you’re 55 or over, you can still put money into a pension. And all that happens is even though you could access it straightaway, you may choose not to. And then the pension fund will build up and you can then access the fund at your convenience or it will just keep on building up and you can pass it on to your spouse or your children. So pensions are a really good way to extract money from a company, but depending on how old you are and your circumstances, you might not be able to access that money straightaway from the pension. That’s a really important thing to keep in mind because if you do try and access the money from a pension before you’re 55, the tax charges are astronomical.

So with pensions, I’m not a financial advisor, so I’d always advise you to go and talk to a financial advisor. And I know some great ones, if you do want a recommendation. But what I would say is pensions, depending on how old you are, can form part of a portfolio of investments for you. And there are often other elements to that portfolio, depending on how you need to be able to access money and how long you want to put money away for. So, this is why pensions are really tax efficient. And actually, one of the really common questions I get asked is, should I contribute into a pension by myself, as in take money out of my business or take money I’ve already gotten, pay it into the pension fund, or should I get my company to pay into that pension fund? So, that’s a really good question.

And the answer is actually quite straightforward most of the time. So essentially, if you contribute into a pension personally, then what the government does is they essentially top that pension up. I believe it’s, if you put £100 into the pension, the government will then top it up to 125 to give you your 20% tax relief. But if you’re a higher rate taxpayer and your tax rate is actually 40%, not 25%, then the government’s still only going to top it up to £125, but what they’ll do is via your self-assessment tax return, they will extend your basic rate band of tax to give you the other 40% tax relief.

So it’s slightly complicated, but ultimately what happens is the government either gives you 20% relief if you’re a basic rate taxpayer or gives you the 40% relief, if you’re a higher rate taxpayer, or 45 or 50, depending on your rates beyond that. So, that’s one thing to factor in. The government will give you tax relief on your pension. But the reason it makes a lot more sense to put a pension and pay it through your limited company most of the time is because, let’s say you take the money out of your business and then you put it into a pension, then the government tops it up by 20% to £125.

What’s actually happened is you’ve got a 20% tax saving there, right? But when you took it out of your business, your business had paid 19% corporation tax on those profits. And then you would’ve had to pay dividend tax, which is seven and a half percent. But because that seven and a half percent is a tax after a tax, it’s really 6%. So you’ve paid 19 plus 6% tax to get the money out of your limited company. So what’s happened is you paid 25% tax overall to get it out of your company, but then you’ve only got a 20% tax saving. So you know what? That’s not bad, but it could be better.

So let’s say you pay for it out of your company, that means you haven’t had to pay that corporation tax. And it means you haven’t had to take the money out as a dividend and pay that dividend tax. So you’ve got that 25% savings straightaway. So paying out of your limited company will give you like an extra 5%. Even at the higher rate, it loosely works out like an extra 5% tax saving on that pension by paying it out of your company rather than taking the money out and paying it personally. So that’s where you really save the tax by getting your company to pay for these pensions.

A few things you need to think about really is obviously a pension is a cost for your business. Depending on how much profit your business has made, it could potentially push it into a loss. That’s one thing. Sometimes you may want to lend your business money, so it can then pay it into your pension. So there is a balance sheet impact of that. So if you run the kind of business where your company’s credit rating is really, really important, then it’s really worth talking to your accountant about what the impact of paying that kind of pension through your business is because earlier I did say most of the time, it makes sense to pay it through your business, but there are times where it can make sense to pay it personally, especially if you’re trying to protect your credit rating.

I believe, although I’m not a hundred percent certain, but that can also have an impact on your mortgage applications as well because if the mortgage lender doesn’t factor in that you paid into a pension, when they’re doing a calculation in terms of your affordability, then actually the company mortgage reference, isn’t going to look as good if you’ve been paying that pension out of the company. So definitely more tax efficient to pay it out of the company, but there can be other factors like your company’s credit rating, and mortgage applications that can be impacted.

Let’s talk about some of the restrictions around pensions and how much you can contribute. So you get a pension allowance and what this pension allowance does is it means you can pay £40,000 a year into this pension. Beyond that, you don’t get the tax relief on it. But I mean, £40,000 a year into a pension’s plenty anyway. And if you haven’t been doing it for the last three years, you can also back date that allowance. So it means the first year you pay into your pension, you can just put a whole 160 K into that if you’ve got that lying around. So in terms of money that goes into your pension, that’s fine.

In terms of what you can pay based on your salary through a limited company, there’s absolutely no restrictions. [Briany, 00:08:40] this was your question yesterday, you might not be taking a salary from your company, but you can still pay into your pension scheme. So I hope that answers it. But if you contribute into a pension personally, then there are restrictions that are based on your income, but then why would you want to do it when you can just put it through your company anyway? So, apart from the two reasons I mentioned earlier. So ultimately, yeah, through your company, you don’t have to be taking a salary to contribute into your pension.

One thing to factor in though, is it is really worth noting though, that everything you do in a business needs to be done on a commercial basis, or it can be challenged by HMRC. If you’ve got the kind of business that has very little trade, it is essentially dormant and then you start lending it like 100 K so you can put that 100 K into a pension, then it’s just worth bearing mind that you will need to justify why your pension payment has been done on a commercial basis. Usually for directors that justification’s easier because…

No, with directors, it’s much harder to measure your financial contribution into a business and the value you generate. How do you measure strategic input and insight? It’s very difficult. So typically directors get it a bit easier when it comes to that financial justification. And yeah, a lot of the time you can make the argument, well, I’ve only been taking a salary of 10 grand a year, but in fact, I’m probably worth like 100 K. So hence the reason I’ve put 90 grand into my pension and HMRC can stomach that. But if you do that with an employee or a family member, who’s not a director, but is an employee, that’s when the justifications are really important.

So doing it through your business, there is no limit in terms of how much you can make, as long as you’re confident it’s being done on a commercial basis. And you can do 40,000 year up to 160, if you haven’t used previous allowances. And one thing to factor in, I’m a little bit rusty on this, so if there’s other accountants watching, just get the gist of it rather than the perfect technicalities of it, please. But you can contribute, I believe £1 million into a pension over the course of your life. And then that pension is then allowed to grow in value to 1.25 million. So what that means is if you contribute over a million pounds into your pension, then you’re going to lose the tax relief and pay tax charges on that additional amount you contribute.

Also, something to factor in, I think the limit is 150 K a year in terms of your income, but if you’re making more than 150 K a year, then I believe you lose your allowances and then you don’t get any tax relief from your pension. But if anyone is making over 150 K and they want me to just confirm the exact details on that, just get in touch.

One really important thing I forgot to mention about the pension though, is you get tax relief when you’re putting money in because your company’s saving corporation tax and you’re saving dividend tax by not having to take it out, but what you’ve got to remember is you also get tax relief on the way out. With a pension, you can do it in one or two ways. Firstly, when you get to 55, you can actually take a quarter of that pension as a tax-free lump sum. So if you’ve got a million pound pension pot, that’s 250 K tax free when you’re 55 and no questions asked.

The remaining 75% you can draw down at your leisure and you’d pay your usual rates of tax on it. Depending on what it is, some of it will be tax free. Some of it will be at the basic rate and some of it will be at higher or additional rates. So a lot of people, what they do is they take that lump sum, they go do something nice with it, like cruise the world and then they just draw down on the pension over time. If you do take the lump sum though, you’re then restricted to, I think, £4,000 a year in terms of what you can actually put into your pension. So the cap goes from 40,000 down to 4,000, if you’ve already taken that lump sum. So definitely worth thinking about that.

This is a bit of a brain spillage of everything I know about pensions. There’s a lot of information here. Feel free to watch a video multiple times. And I’m sure there’s other things about pensions, which will come to mind down the line. But the point being though is, and obviously there’s all the different kinds of pensions, but that’s something a financial advisor can really talk to you about, but one of the really relevant ones for business owners is called a SIP, a self-invested pension plan. So what the SIP does is it lets you actually control your pension and its investment. So you can put money into the pension, you can then go and utilize that money, how you wish with certain restrictions.

But one of the most common uses of SIP is when people trade a business under a property. Like if you’re a mechanic and you’ve got a garage and you want to buy that garage, you can actually buy it through your pension plan rather than buying it personally. And the tax savings and tax benefits of doing that through a pension rather than buying premises for your business yourself are awesome.

So yeah. Look, ultimately I’m not a financial advisor. I’m not licensed to give people pension advice. All I can do is comment on the tax implications, but there are good financial advisors out there and a lot of the time they don’t charge for an initial consultation. So if you’re ever thinking about any of this, it’s worth getting in touch with a financial advisor or someone who can get you in touch with a good one and they can give you some really detailed advice and useful advice about what pensions mean for your retirement.

So I think I just beat a record for my longest video. Hopefully the other ones won’t be too long, but there is a lot to pensions. Right. So now for the sales pitch, look, the reason I do these videos about tax is because tax should be the easy bit. The hard bit is building your million pound business. So what is a million pound business? A business you can sell for a million pounds. So why do you want a million pound business? I don’t know. It means different things to different people. But what we do at N-Accounting, we’ve got a signature solution, it’s called Apex and we help business owners build their million pound business. We do it through getting all their accounts and tax work done. That’s the easy bit. But what we then do is make sure they understand their numbers inside out. They understand their goals, their targets, their KPIs inside out. And then what we do is we have a whole coaching program attached to it, to build the million pound processes that will make a business worth a million pounds.

If you want to find out more about Apex and N-Accounting and what we do to help people build that million pound business, then I would like you to get in touch and book yourself in for a free strategy session with myself. And just remember, if you found this video useful, remember to like, follow, subscribe, and I will catch up with you in the next video, which will be parts one and two. So not quite in order, but Briany, had to answer your question. All right. Thank you. Okay, bye.

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