Time to switch dividends for company pension contributions?

Time to switch?

As a rule of thumb, dividends are the most tax-efficient way to extract profit from your company. However, company and personal circumstances can change that. Are pension contributions worth considering too?

Tax and profit extraction

Since April 2016 the government has introduced a number of measures that have eroded the personal tax advantages for director shareholders of companies, in particular increased income tax on dividends. Nevertheless, with few exceptions dividends produce the greatest net income for shareholders compared with taking income in other forms, e.g. salary or benefits in kind. However, if you don't have an immediate need for income you should consider reducing dividends in favour of pension contributions for longer term tax efficiency.

Company or personal 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 (see The next step ).

Tip. If your pension plan doesn't accept employer contributions, it's usually easy to make a change to allow them. Speak to your financial advisor or the pension company.

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

How much can you pay?

While your company can pay substantial amounts into a registered pension scheme, for you there is a point at which they become less tax efficient than taking equivalent dividends. The optimum amount is that which brings your total pension contributions (personal and company) up to £40,000 in a year (the annual allowance).

Tip. If annual allowances haven't been fully used in the last three tax years, your company can use them to make a larger pension contribution in 2020/21. For example, if your total pension contributions were £8,000 for each of 2017/18, 2018/19 and 2019/20, the shortfall of £32,000 per year, £96,000 in total, is added to your annual allowance for 2020/21.