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Tax Relief On Pension Contributions By Employees And Employers

January 29, 2016

Are you looking to make your next investment?

Have you worked out the tax incentives of investing in a pension?

The problem — pensions can be confusing

I know from talking to clients that they are not investing in pensions. There are a number of reasons why this is the case, here is a brief list of some of the common ones I hear:

– They can’t get access to the money now and have to wait until they retire

– Pensions themselves can be quite difficult to understand

– Pension growth is seen to be small compared to other investments

– The costs of running a pension are high

Can you relate to the above?

Are the above reasons why you are not investing in pensions right now?

If you have answered yes to these questions then you might be surprised to learn you could be missing out.

There are many advantages to pensions. These include:

– Tax relief on pension contributions

– The fact that income generated from the pension is tax-free

– The capital growth of the pension will always be tax-free until you withdraw the investment

– Pensions may be controlled by you to invest in commercial property

What is a pension anyway?

A pension, in short, is a pension scheme or arrangement whereby it provides benefits in one or more of the below circumstances:

  • retirement
  • death
  • having reached a particular age
  • serious ill-health or incapacity, or
  • similar circumstances.

Types of pension benefits

The pensions tax legislation categorises the type of benefits a pension scheme will provide into the following four types of pension benefits:

Defined benefit – these schemes should provide a set amount of benefit, where the amount of benefit does not depend on how much money is within the scheme. Final salary and career average schemes are examples of defined benefit schemes.

Money purchase – also known as defined contribution. The amount of pension is not known in advance as it will depend on how much money is in the scheme. The size of the member’s pension pot in the scheme will depend on the amount that has been contributed to the scheme.

Cash balance – these are a type of money purchase scheme. For the purposes of providing member benefits the rules are the same as for money purchase/defined contribution benefits. The difference between pure money purchase and cash balance is that the size of the member’s pension pot isn’t only dependent on the contributions that have been paid to the scheme.

Hybrid – these schemes may provide either defined benefit, money purchase or cash balance benefits. Only when benefits are drawn will the form of the benefit be set.

Types of pensions — employee contributions

An employer pension scheme is often referred to as an occupational pension scheme and may provide benefits as outlined above for its employees under Section 150(5) of the Finance Act 2004 and Section 30 of the Finance (No 3) Act 2010.

Employees can obtain tax relief on contributions they make from their own earnings into their pension up to a maximum of:

  • £3,600 (for those not paying income tax); or
  • the entirety of the member’s relevant UK earnings (up to the annual allowance)

While those making pension contributions will benefit from tax relief on their contributions, this is limited to £40,000 per year (pension contributions annual allowances) and there is a lifetime contributions allowance of £1,250,000 (tax year 2014-15).

You can go back two tax years and make pension contributions to utilise your annual allowance. Therefore you could, in effect, make £120,000 of pensions contributions in two years’ time.

If you make pension contributions and are not part of a “salary sacrifice scheme” then you may only receive basic tax relief from the pension scheme. As such you will need to reclaim the additional tax if you are a higher rate or additional rate taxpayer on your self assessment. You’ll get a statement from your pension provider telling you how much tax you owe if you go above your lifetime allowance. Your pension provider will deduct the tax before you start getting your pension.

Types of pensions — employer contributions

Employers may make pension contributions for their employees. There is no limit to the amount of money that the employer may contribute on behalf of an employee.

An employer’s contribution acts as a cost to reduce corporation tax

Employers may reduce their corporation tax liability by the amount of money that they have invested into the pension as it is deemed that employer contributions are an allowable cost.

Sections 307 and 308 of the Income Tax (Earnings and Pensions) Act 2003

The contributions an employer makes to a registered pension scheme on behalf of an employee are exempt from being taxed as earnings for the employee. However, the employer’s contributions will count towards the member’s annual allowance limit, so the member may have to pay tax if the employer contributes too much.

Where the employer is a company with investment business the employer contributions will be deductible as an expense of management (Chapter 2 of Part 16 of the Corporation Tax Act 2009).

Payments made on behalf of directors and shareholders of the company 

Payments made on behalf of the directors/shareholders are considered to be wholly and exclusively for the purposes of the trade. As such these contributions will benefit from corporation tax relief.

If you are part of an employer scheme and you personally make pension contributions, you are entering into a salary sacrifice arrangement whereby you get tax relief at source on pension contributions in each and every pay packet, be it weekly or monthly.

Getting money out of a limited company

Now you can see how you can genuinely get money out of a limited company through the employer contribution towards your pension.

Practical steps you should now take to make the most of your pension

If you want to be more tax efficient or if you would like to discuss other finance/tax questions then please book some time with us using the below calendar:

If you are looking for a new accountant then please book some time with us using the below calendar. Please note that this booking is to describe our services and will not be used to discuss your personal tax affairs.



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Telephone: 0115 939 4606
Email: simon@optimiseaccountants.co.uk