Putting money into a pension is a very good way of reducing the amount of money you need to pay in Income Tax and National Insurance contributions.
You can pay money towards a pension in two principal ways. The first way is to contribute personally, the second is to arrange contributions into a pension fund from your business.
Paying into a personal pension
When you pay money into a pension scheme from your own money, the money you pay in, benefits from personal tax relief. The pension provider will add 20% to whatever contribution you make, effectively extending your basic rate of tax by the grossed up pension contribution. So, for example, if you put £8 into the fund, your provider would increase that to £10. Your basic rate band will also be extended by £10.
Although you can pay as much money into a pension as you wish, tax relief will only apply on the contributions up to a maximum of 100% of your salary. That means if you pay more money into a pension in a given year than you have earned, you will not receive any tax relief on the amount exceeding your total earned income in that year.
Paying into a company pension
Paying into a company pension is slightly different in that rather than coming from your own funds, the pension contribution would be made on your behalf from your company’s funds. These pension contributions still benefit from tax relief, but rather than gaining Income Tax relief, they attract Corporation Tax relief.
To be entitled to Corporation Tax relief, HMRC states that the contributions must be made wholly, and exclusively, for the purpose of trade. In practice this means that the combined salary and pension that the company employee or company director receives in the year is ‘reasonable’, and does not cause the company to make a loss.
The maximum amount you can pay into a pension in any given year is £50,000. The maximum amount you can pay in over your whole life is currently £1,800,000, and will be reduced to £1,500,000 from the 2012/13 tax year. Paying in more than these amounts into a pension fund will trigger additional tax requirements.
If you do pay money into a pension scheme through your company, you must make sure that the provider knows it is coming from a company rather than an individual, and you should ensure that you make the contributions from a company account rather than your own personal account.
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