Spouse pension contributions via company

Published: 09 Nov 2012

Updated: 16 Oct 2023

Written by Ray Coman

Pension contributions can save considerable tax for self-employed individuals and contractors using companies to provide their services.

A self-employed person can save considerable national insurance contributions (NICs), over being a sole trader, by receiving income into a company and withdrawing profits in the form of dividends.

There is scope to save income tax as well, by retaining assets in the company and making withdrawals in a tax year in which there is capacity to receive income not taxed at a higher rate. However, where this is not practical there would be no real difference in tax apart from the NICs saved.

To the extent that dividends put total income into higher rate tax there is an effective 25% tax. However, where all profits are withdrawn from the company by its only shareholder, the rate could be regarded as 20% rather than 25%. The income has been drawn from profits after corporation tax (currently 20%). Where all cash is cleared from the company, a limited company owner is liable to the same in income tax and corporation tax as an employee or self-employed individual.

To illustrate, for a higher rate taxpayer, company profits of £10,000 are subject to corporation tax of £2,000, and the remaining £8,000 is subject to 25% income tax of £2,000. The total tax of £4,000 is equivalent to 40% of the gross.

A tax efficient method for extracting profits from the company is via pension contributions.

Employer contributions are preferable to employee contributions made to the same person. An employee's contribution is limited to the amount of relevant earnings. As relevant earnings do not include dividends, the earnings may not be more than the minimum director salary. If the director's salary has to be increased beyond the primary earnings threshold, then national insurance would be payable. Unfortunately, pension contributions would not reduce NICable earnings for a director. For the above reason, an employer scheme offers more flexibility and tax saving to business owners.

Where pension contributions are paid on behalf of another person, such as a spouse, the marginal rate of the payee is used to determine the tax relief. Therefore, a higher rate tax payer would not obtain higher rate tax relief by paying into the pension pot of their basic rate tax paying spouse. However, the same does not apply to employer contributions. It is in effect possible to achieve a higher rate tax saving by paying employer pension contributions in a spouse's scheme, where the tax would otherwise be suffered at a marginal rate of 40% in the shareholders hands.

Employer contributions into a spouse pension would have a further advantage to taxpayers who have already contributed the maximum on which higher rate tax relief is available (of £50,000 per person, per year for 2012-13.) There is a further potential tax saving for the couple to consider where each spouse would be subject to different rates of tax on eventual receipt of the pension income.

Coman & Co, chartered tax advisers, have detailed knowledge on remuneration planning, and can help reduce tax for you and your family, in line with your personal and business goals. Please contact us for an initial consultation.