As a business owner, you likely have a very busy to-do list. When you are handling the day-to-day running of your company and designing a vision for the future, you might not have time to think about your pension.

You would not be alone in this, as PensionsAge reported that 76% of self-employed people surveyed were not paying into their pension and 38% did not have a pension at all.

Failing to pay into a pension could make it more difficult to save for retirement and meet your financial goals later in life. Additionally, you could be missing out on some excellent tax benefits.

Read on to learn why pensions can be such an effective and tax-efficient tool for business owners.

Saving in a pension could help you secure your dream retirement

If you want to enjoy your dream lifestyle in retirement, it may be useful to think about how much that will cost and what you need to save to achieve it.

Saving in a pension can be far more effective than putting your wealth into cash savings or relying on funds from your business for several reasons.

Firstly, your pension is a dedicated pot that you cannot normally access until you are aged 55 (increasing to 57 on 5 April 2028). As such, you cannot be tempted to withdraw the funds early for use elsewhere.

Additionally, your funds are invested in a range of assets, giving your savings the potential to grow significantly over time. This growth could help you counteract the effects of inflation, so your wealth maintains its value in real terms, and you can generate interest or returns within a tax-efficient wrapper.

You can also receive tax relief on your pension contributions. This could help you build your retirement fund faster, meaning you can build a larger pot and potentially enjoy a better quality of life in later life. Find out more about tax relief below.

You could benefit from tax relief on employee contributions

If you are a sole trader or partner, you can enjoy some tax advantages by paying into a pension, including tax relief.

Essentially, when you contribute to a pension, some of the money that would have gone to the government as Income Tax is paid into your pension instead. The rate of tax relief you receive depends on your marginal rate of Income Tax.

You will automatically receive 20% tax relief at source when contributing to your pension. If you are a higher- or additional-rate taxpayer, you may be able to claim more tax relief through self-assessment.

This tax relief is applied on all contributions up to your Annual Allowance of £60,000 (or 100% of your earnings if lower) in the 2023/24 tax year. If you are a higher earner or you have already started to flexibly draw from a pension, your Annual Allowance may be lower.

Figures from PensionBee demonstrate the difference that this tax relief could make to your savings over time.

They report that saving £8 a month for a decade amounts to £960 in contributions. If you put these funds in a cash savings account with an interest rate of 5%, you would earn £307.85, giving you a total of just under £1,268.

Conversely, if you put the same amount into a pension with an additional £2 a month in tax relief, 5% annual growth and 0.7% annual fees, your savings would grow by £563.76, a total of just under £1,524.

This is because the tax relief on your pension contributions gives you a valuable boost to your savings. In the example above, £240 of the growth is from tax relief alone.

These figures are small, and they only cover a 10-year period, but they demonstrate the significant difference in growth thanks to tax relief. 

Over a longer period of 30 to 40 years, with higher contributions, the benefits of paying into a pension could be far more pronounced.

Bear in mind that if you exceed your Annual Allowance, you may not be able to make any further tax-efficient contributions to your pension in that tax year.

Employer contributions may count as a business expense

If your business is a limited company, you may decide to pay pension contributions directly from the business rather than your own salary. As a result, the contributions may be considered business expenses, and you might enjoy some significant tax advantages. 

Firstly, you can offset the expenses against your Corporation Tax bill. This effectively reduces your profits, meaning that you pay less tax. This may be especially beneficial considering the rate of Corporation Tax increased on 5 April 2023 to 25% for companies with profits of more than £250,000. 

You might be facing a larger tax bill as a result of this change, and using pension contributions to reduce Corporation Tax could help you mitigate this.

Additionally, your business does not have to pay National Insurance contributions (NICs) on any payments into a pension. These extra funds could be added to your pension to help you grow your savings faster. 

As a result, you may be able to boost your retirement fund while also reducing the tax that your business pays.

However, to gain these tax advantages, you may need to prove that your contributions are exclusively for business purposes, and that they are reasonable considering the level of work that you do. They also need to be in line with the contributions that the business makes to other employees who do a similar level of work.

It is important to consider your Annual Allowance

Before you look to make the most of pension contributions, it is important to bear the pension Annual Allowance in mind.

Business owners often pay themselves a smaller salary and then boost their income with dividends.

This may be more tax-efficient because you do not pay Income Tax on any income below the Personal Allowance of £12,750, and dividends are taxed at a lower rate than income. 

Additionally, you have a Dividend Allowance of £1,000 in 2023/24 (falling to £500 on 5 April 2024), meaning the first £1,000 you pay yourself in dividends is not subject to tax.

However, it is important to consider how this could affect your pension Annual Allowance.

In 2023/24, your Annual Allowance is £60,000 or 100% of your earnings, whichever is lower. You can only make tax-efficient pension contributions up to this amount. You may be able to make higher pension contributions by carrying forward any unused Annual Allowance from the previous three years.

As such, if you take a low salary, this could limit your ability to make tax-efficient pension contributions.

Consequently, if you want to receive more tax relief and build your pension savings, you may want to consider increasing your salary, so you have a higher Annual Allowance.

That said, every situation is unique and the tax implications of this can be complicated. It may be beneficial to seek professional advice to determine the best course of action for you and your business.

Get in touch

If you want to explore the potential benefits of paying into a pension, then please do get in touch with us at DBL Asset Management.

Email or call 01625 529 499 to speak to us today.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.

The Financial Conduct Authority does not regulate tax advice.