Dividends vs Pension Contributions

Tax

Dividends

Withdrawing profits from your company in the form of Dividends is one of the most Tax efficient methods of taking money from your limited company. Other methods of withdrawal, such as salaries or benefits in kind, are less efficient once you have exceeded the Personal Tax Allowance of £12,500 (to 5th April 2021).

Tax on Dividends is taxed at the basic rate of 7.5% followed by income at the higher rate of 32.5%. With the first 2,000 Dividends tax free. These rates are much lower than income tax rates which are taxed through salary at 20% and 40% retrospectively. Because of these reduced rates on Dividends, it is most Tax-efficient to draw from the limited company through this method.

However, if you do not have an immediate need for income you should consider reducing dividends in favour of pension contributions for longer term tax efficiency.


Pension Contributions

Registered pension schemes can accept contributions from you personally or direct from your company on your behalf. The latter, known as employer contributions, are slightly more tax efficient.

While your company can pay substantial amounts into a registered pension scheme, the optimum amount will bring your total pension contributions (personal and company) up to £40,000 in a year.

You are however able to use any unused allowance in the last three Tax years to enable you to utilise any shortfalls in previous years contributions.

Pension contributions have the advantage that your company can pay them even where it hasn’t made profits. This isn’t allowed with dividends.

The disadvantages of pension contributions, compared to dividends, is that you must wait until you are 55 to withdraw the funds.


Summary

If you do not need to take all the profit from your company, extracting it as an employer pension contribution is a more tax-efficient alternative.

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