Dividends v Pension Contributions Revisited

Published / Last Updated on 14/05/2021

Many business owner/directors have decisions towards year end when businesses are in profit as to whether they pay corporation taxes and retain that profit in the business for net dividend distribution or they can, if they choose to make an employer pension contribution instead into their own pension scheme.

As a dividend, you will also pay additional income taxes after deduction of the £2,000 pa tax free dividend allowance.

In most cases, it is usually more beneficial to have it paid as a pension contribution as it is fully offsetable as a business expense against corporation tax and then you can drawdown funds from pensions when ready to control your taxes as well as in the event of premature death, the pension fund may be paid tax free to loved ones.

Our view is that it will always be a balancing act between accessible capital in the form of dividends and building up pension contributions as efficiently as possible without paying corporation tax.

e.g,  £30,000 PROFIT - Dividend v Pension.  We think pension is usually better than dividend now across all scenarios

£30000 Paid to You

Dividend – paid out to you as net dividend

Pension - £30000 Paid into Pension

Corporation Tax Payable 20%

£6,000

NIL

Net Payment to you

£24,000

£30,000

Employers National

Insurance

NIL

NIL

Employees National Insurance

NIL

NIL

Money Now in Your Name

Basic Rate Taxpayer (20%)

£24,000 Dividend

less £2,000 Tax Free Dividend Allowance

£22,000 taxed at 7.5% = £1,650 Tax

 

In Your Pocket

£24,000 less £1,650 Tax = £22,350

£30,000 in pension fund

But if then use flexible drawdown

£30,000 X 25% Tax Free Cash = £7,500

£22,500 X 20% Income Tax = £4,500 Tax.  Net Left = £18,000

 

In Your Pocket £7,500 + £18,000 = £25,500

Money Now in Your Name

Higher Rate Taxpayer (40%)

£24,000 Dividend

less £2,000 Tax Free Dividend Allowance

£22,000 taxed at 32.5% = £7,150 Tax

 

 

In Your Pocket

£24,000 less £7,150 Tax = £16,850

£30,000 in pension fund

But if then use flexible drawdown

£30,000 X 25% Tax Free Cash = £7,500

£22,500 X 40% Income Tax = £9,000 Tax.

Net Left = £13,500

In Your Pocket

£7,500 + £13,500 = £21,000

Money Now in Your Name

Higher Rate Taxpayer (45%)

£24,000 Dividend

less £2,000 Tax Free Dividend Allowance

£22,000 taxed at 38.1% = £8,382 Tax

 

 

In Your Pocket

£24,000 less £8,382 Tax = £15,618

*£30,000 in pension fund

But if then use flexible drawdown

£30,000 X 25% Tax Free Cash = £7,500

£22,500 X 45% Income Tax = £10,125 Tax.

Net Left = £12,375

In Your Pocket

£7,500 + £12,375 = £19,875

 

 

*May pay additional tax if Tapered Annual Allowance applies to Pension Contribution

Tax on Death E.g.  Basic Rate Tax Payer

Inheritance Tax 40% =

£22,350 X 40% = £8,940

 

Net Paid to Loved Ones £13,410

(more than half of starting £30,000 gone in tax)

Untouched Pension Fund =

£30,000 paid to loved ones

 

or Drawdown Pension Balance

Death before Age 75 = NIL TAX

Death After Age 75 = Loved ones pay tax when drawing pension fund at their rate of income tax

Could be 100% of £30,000 never gets taxed

Tax on Death E.g.  Higher Rate Tax Payer

Inheritance Tax 40% =

£16,850 X 40% = £6,740

 

Net Paid to Loved Ones £10,110

(nearly 2/3rds of starting £30,000 gone in tax)

Untouched Pension Fund =

£30,000 paid to loved ones

 

or Drawdown Pension Balance

Death before Age 75 = NIL TAX

Death After Age 75 = Loved ones pay tax when drawing pension fund at their rate of income tax

Could be 100% of £30,000 never gets taxed

Tax on Death E.g.  Additional Rate Tax Payer

Inheritance Tax 40% =

£15,618 X 40% = £6,247

 

Net Paid to Loved Ones £9,370

(more than 2/3rds of starting £30,000 gone in tax)

Untouched Pension Fund =

£30,000 paid to loved ones

 

or Drawdown Pension Balance

Death before Age 75 = NIL TAX

Death After Age 75 = Loved ones pay tax when drawing pension fund at their rate of income tax

Could be 100% of £30,000 never gets taxed 

The above assumes corporation tax and dividend income rates and allowances as above but are subject to change.

Contact  Book A Call  Calculators  £ Fees £


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