The top tax year end questions answered

Tax year end is a busy time for the Technical team at Royal London and we thought it would be useful if we shared the most common questions we receive in the run up to that 5 April deadline.

Tax relief and annual allowance

One of the top questions we’re asked about is annual allowance and carry forward. But that often highlights that we’re being asked the wrong question first. Why? Well often the question should be about tax relief, not carry forward.

The first question asked by technical teams in response to a question about carry forward isn’t how much annual allowance someone has but how are they paying the contribution? If it’s an individual contribution, then the client will still need relevant earnings in the year of payment to support the contribution.

For example, if there’s £100,000 worth of unused annual allowance, the client will need earnings of at least £100,000 in order to make an individual contribution of this level and receive tax relief. Often, we’ve been asked to help work out or check someone’s available annual allowance and only later do we find out they don’t have the earnings to support the contribution.

A good starting point is to establish the type of contribution first. Think big first. If it’s an individual contribution, what’s the maximum tax relievable contribution which can be paid by the client? Then work out how much annual allowance they need and whether they need to look at carry forward.

Carry forward and annual allowance 

The specific year of payment is also important at tax year end, as what if next year the client doesn’t have the relevant earnings to support the contribution? Often, we see clients with inherited money who want to make a large pension contribution. That’s a great idea, as we know pensions are a fabulous wrapper due to the potential tax relief available as well as helping satisfy a retirement income need.

However, if they’ve inherited £200,000, but only earn £60,000, then having carry forward is irrelevant as they can only contribute a maximum of £60,000 and will use this year’s annual allowance first.

It’s important to remember, if they’re already contributing to a pension, it’ll be less. What they can do, is split this over different tax years. Getting that contribution paid in this tax year becomes very important. Pensions are tax reducers, so making large contributions in different tax years will mean a large reduction in the amount of income tax being paid as well. Plus, if your clients are a couple – can it be paid by both of them?

Of course, carry forward and annual allowance are the top tax year end queries. But we’re often asked about other areas which cause confusion. What opportunities are there at tax year end? How can clients make the most of it? At tax year end many of these questions come from spikes in earnings which might not happen again. So thinking about adjusted net income and tax traps are crucial.

Spikes in earnings

Let’s start with a reminder about adjusted net income and when you need to think about it. We know that paying a pension contribution is hugely tax efficient due to the tax relief on offer. Most higher-rate taxpayers are basic rate taxpayers in retirement. So for every £100 they withdraw from their pension, they’ll receive £85. This isn’t bad if the contribution cost £60 for every £100. Our tax system’s progressive and the amount of tax you pay should increase as you earn more, but there are tax traps where more tax is paid than should be. The personal allowance tax trap is one of those.

If adjusted net income is over £100,000, then a client starts to lose their personal allowance on a 2:1 basis until they lose it completely. 60% tax is paid instead of 40%. Basically, adjusted net income is total taxable income, less pension contributions, gift aid and trading losses. However, if a pension contribution is made, that 60% tax becomes 60% tax relief (or 61.5% in Scotland due to higher taxation).

It can be even better if the employer pays that final contribution for redundancy or bonus via salary exchange, as there’s a National Insurance saving as well.

The wholly and exclusively rule

A common question is in relation to how much can be paid as an employer pension contribution by a company, and often that question is linked to maximising pension contributions and using up carry forward. Technically the answer is that it’s unlimited. But it’s subject to the wholly and exclusively rule.

Most employer contributions will satisfy this rule as it’s for the purpose of their trade. When doesn’t the wholly and exclusively rule apply? Well, if it looks a bit odd, then it probably is. For example, if one employee, who isn’t a director but might be a family member, is getting a very large pension contribution and other employees aren’t, that wouldn’t satisfy the wholly and exclusively rule because it isn’t for the purposes of trade. In some cases, making the family member a director and giving them director’s duties would satisfy this rule. Structuring the business in the correct way is important.

Salary versus dividend versus pension

At tax year end, business owners are considering how best to remunerate themselves and what to do with available money in the business. So what’s the best combination,
especially for the person who wears the hat and pays the tax of employer and employee? Salary, dividend or pension? Well, for most people it isn’t a choice of one of those but instead, a combination of all three. Pensions will always win as the best wrapper, but unless you’re over 55, they aren’t going to help with the mortgage and the shopping bills. So let’s have a closer look at those options and the tax walls that impact them.

Salary

• Employer - National Insurance (NI) is payable, dependent on the level taken, but no corporation tax. Employer NI is due to increase from 13.8% to 15% from 6 April 2025.
• Employee – income tax and employee NI dependent on the level taken.

Dividends

• Employer – corporation tax is due.
• Employee– income tax at the dividend rates which are 8.75%, 33.75% and 39.35%. There’s the dividend allowance of £500, but bear in mind that this does sit within the tax stack. So if I have £5,000 of dividends and earnings of £50,000, £500 will be tax free, but it will use the remainder the basic rate band and then £4,500 will be taxed at 33.75%.

Employer pension contributions 

• Employer - no corporation tax and no employer NI.
• Employee – no income tax until pension benefits are taken and no employee NI.

Other things to think about: 

• Is there available carry forward?
• Has the director been a member of a pension scheme in the past?
• Is there too much cash in the business?*

*This is important when thinking about IHT planning as if there’s too much cash in the business, it might not all qualify for business relief. In addition, if the business folded, that cash would be an asset of the business and not protected as it would normally be in the pension wrapper.

• How old is the director?
• Is there a plan for retirement?
• Is there a value in the business and how likely is it there will be a value in years to come? The last few years have shown us that the businesses we thought were rock solid, aren’t always.
• Is enough salary being taken to make sure that state benefits will be payable including state pension and other state benefits? Not forgetting maternity allowance for your female clients.  

What impact will the change in employer NI contributions have?

From 6 April 2025 the rate at which employers pay NI contributions will increase from 13.8% to 15% and in addition to this, the threshold from which they become payable reduces from £9,100 to £5,000. Perhaps providing some relief against this are the changes to the Employment Allowance, which is the portion of employer NI contributions that the employer doesn’t have to pay. Until 6th April 2025, this is only available to employers that have a total NI bill below £100,000, and if this is the case, they don’t have to pay the first £5,000 of employer NI they would otherwise have been liable for. From 6 April 2025, as well as the £100,000 cap being removed, meaning this is available to all eligible employers, the allowance has increased. From that date, eligible employers won’t have to pay the first £10,500 of the NI bill they would otherwise have been liable for. The upshot of this is that some employers’ will see their NI bill reduce, some will see no change, and others will see their NI bill increase.

Some employers may previously have set their own salary at the threshold for employer NI of £9,100, which is above the salary point of £ 6,725 to obtain a qualifying year for state pension. With the threshold for employer NI decreasing to £5,000, care needs to be taken to ensure any salary reduction they may consider, doesn’t impact eligibility for state benefits.

Is there anything employers can do to mitigate the impact of the NI changes?

For some employers, these changes will have a significant impact, and research carried out by Royal London in early November 2024 suggests employers are considering a range of measures including recruitment freezes, limits on salary increases and increase in prices of the goods and services they produce. One way to mitigate the impact of the increase in employer NI is to introduce salary exchange for workplace pension contributions. When using salary exchange, employees see their gross salary reduced in return for a non-cash benefit, such as an employer pension contribution. As less gross salary is being paid, the employer makes a NI saving which can either be redirected into the employee’s pension, or retained in the business to help offset some of the NI increase on the non-exchanged salary.

If you need further help in this area, there are case studies about extracting company profits on the Technical Central area of our website.

Summary

We hope these prompts help you with your tax year end planning and making the most of the opportunities for your clients.