Why it’s time to re-visit Pension contributions to beat the increase in Dividend Income Tax after the 6th of April

If as an owner-director of a Private Limited Company you draw the majority of your income as dividends, your income tax liability is set to increase in 2022/23 due to the rise in Dividend Income Tax.

The new tax year will see Basic, Higher and Additional Rates of Income Tax on Dividend income rise by 1.25% to 8.25%, 33.75% and 39.35% respectively.

One answer to avoid this increase is to revisit Pension contributions.

Qualifying Employer Pension Contributions may allow you to extract taxable profits from your business without incurring Dividend Income Tax and Corporation Tax for you and your company.

Where these surplus profits are not needed immediately, the initial tax savings, gross roll-up of investment returns and future tax treatment on pension withdrawals can provide a significant uplift in value against taking additional dividend income and investing in alternative solutions.

Let’s look at an example:

John, age 50, is a higher rate taxpayer. He has surplus profits of £10,000 accruing in his Ltd Company, which he is considering drawing as an additional Dividend Payment and adding this to his existing Stocks and Shares ISA to support his retirement planning. 

After Corporation Tax at 19% and Higher Rate Dividend Income Tax, John has £5,366 to invest and achieves an annual return of 5%. After 10 years John’s ISA has grown to £8,741 which he can withdraw free of any taxes as and when required.  

Alternatively, John may receive a gross £10,000 employer pension contribution to his existing pension free of any Corporation Tax or Dividend Tax liabilities.

After 10 years at the same investment return John’s Pension fund has grown to £16,288.

He draws a 25% tax-free lump sum and the remainder as a taxable income payment. Allowing for 40% higher rate income tax, John receives an overall net payment of £11,402.

The additional £2,661 received accounts for 30% more than the alternative initial Dividend and subsequent ISA investment would have offered.

Whilst there are a number of additional factors to take into account, such as the Annual Allowance for tax relieved pension contributions and the minimum pension age, the potential benefits of making additional pension contributions cannot be disregarded.

Further potential increases in the Corporation Tax rates that may be applicable to your business from 2023 onwards may serve to increase the tax efficiency of this option.

Prior to making any additional Pension contributions, I recommend that you speak with an Independent Financial Planner to ensure this course of action is suitable for your personal circumstances and objectives.

To speak to one of our Financial Planners please contact us on +44 (0)330 124 1399 or complete our online enquiry form.

The content of this article is for information only and does not constitute formal financial advice. This material is for general information only and does not constitute investment, tax, legal or other forms of advice.

You should not rely on this information to make, or refrain from making any decisions. Always obtain independent, professional advice for your own particular situation.

Kreston Reeves Financial Planning Limited, Independent Financial Advisers. Authorised and regulated by the Financial Conduct Authority.