Pension contributions and corporation tax - July 26th 2023

Owner-managed companies with profits in the region of £150,000 to £250,000 are facing a significant tax hike this year. However, the tax increase can be mitigated by the company making pension contributions into a director’s self-invested personal pension (SIPP).

A company with a 31 March year end and profits of £150,000 will find that its corporation tax bill for the year ended 31 March 2024 has increased by some £7,500 compared with the previous year. This is because profits between £50,000 and £250,000 are now taxed at a marginal rate of 26.5% compared with 19% previously.

Tax planning                                    

Directors who have previously been reluctant to make sizable pension contributions – possibly because of a perceived lack of control over the pension fund – may now find a compelling case for doing so. Take the above example:

• If the company invests a maximum of £60,000 into a self-invested personal pension on behalf of its director, this will save corporation tax of £15,900 – much more than the additional £7,500.
• Once the director reaches 55, 25% of the pension fund can be withdrawn tax free. If a director is already 55 the funds are available immediately.
• If the remaining pension fund can be withdrawn so that just 20% basic rate tax is payable by the director, the overall tax rate on the pension income will be 15%. Very roughly, this allows the tax saving on the pension to balance out the additional tax cost faced by the company.
• Although there may not be any overall tax advantage as such, there is a timing benefit. The current year’s corporation tax bill is cut, but the tax cost does not come in until the director retires and draws the pension income.

It is even possible to avoid the future tax cost altogether if the director doesn’t take any pension income apart from the 25% tax-free lump sum. Should the director die before reaching 75, the remaining pension fund can be passed to their family without any tax implications.

Timing is critical: the pension contribution must be made before the end of the company’s accounting period. Unless income is fairly regular, a profit forecast will be necessary.

Mitigating cost and risk

Low-cost providers allow the annual cost of maintaining a SIPP to be kept to a minimum. For example, one major provider limits annual account charges to £200.

One advantage of SIPPs is that they offer investment freedom. If a director has only a few years until retirement, they might not want to be exposed to stock market volatility. Investing in a fixed-term cash deposit account will avoid this risk. Although such an investment is unlikely to grow in line with inflation, the interest received will be tax free within the pension fund. On a five-year fixed rate deposit, interest of around 4% can currently be obtained, equivalent to a gross 6.7% for a higher rate taxpayer.

Future tax changes are always a possibility, now in particular given a general election is not far off. The 25% tax-free lump sum could well be at risk, which is why it may be advisable to take this as soon as possible.