Your spouse is taking a break from work and only has income from savings but wants to continue making contributions to their pension fund. Would it be tax efficient for you to pay these from your business?
Pension contributions for all
One of the advantages of the current pension regime is that tax relief is allowed for contributions regardless of who the fund is for. For example, you can pay contributions into a fund for your spouse, child or even a friend. You’ll receive the basic rate tax relief, and if they pay tax at the higher or additional rate, they can claim the extra.
Example. Harry is married to Sally. She only has income of a few hundred pounds per year. The pension rules allow Harry to pay £3,600 per year to a pension for Sally. After basic rate tax relief (20%) the amount he has to pay the pension company is £2,880.
Tip. If Sally had earnings from employment or self-employment which exceeded £3,600, either she or Harry (or together) could pay contributions to the level of her earnings.
Company contributions option
As a director shareholder Harry arranges for the company to pay his pension contributions rather than pay them himself. This is a tax and NI-efficient way to extract income from a company compared with taking dividends or salary. The efficiency exists because employer contributions are exempt from tax and NI. Harry’s thinking is that if the exemption extends to contributions his company pays for Sally’s pension, he’ll make further tax and NI savings.
Does the exemption apply?
After a look at the legislation, Harry’s hopes were high. S.308 Income Tax (Earnings and Pensions) Act 2003 says “No liability to income tax arises in respect of earnings where an employer makes contributions under approved personal pension arrangements made by an employee.” As Harry sees it, he is making the “arrangements” and therefore if his employer, i.e. his company, pays the contributions, the exemption applies.
Trap. HMRC’s view is that the pension plan must be for the benefit of the employee for the exemption to apply. While the wording of the legislation isn’t clear, we feel that HMRC is probably right. This means that if Harry’s company paid into a pension plan for Sally, it would count as his taxable income. So for a £3,600 contribution, assuming he’s a higher rate taxpayer, the total tax and NI cost for him and his company would be £1,158.
Company pays – an alternative
Because of the Trap it seems that paying Sally’s pension contributions shouldn’t be made by Harry’s company. So Harry is back to paying them. At best the tax cost is then £936, which is an improvement, but there’s an alternative.
Tip. If Harry transfers some of his company’s ordinary shares – it doesn’t have to be a significant proportion of his shareholding – to Sally and the company pays the £3,600 contributions for her, it counts as a distribution, which is taxed like a dividend on her. Because she can use her personal tax-free allowance the tax cost is now zero. Even if her income were greater she could make use of the lower tax rates and would still mean that the company-paid contribution is the clear winner.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.