Business structures and pensions

The way in which a business is set up affects the way it can pay pension contributions and the tax relief it can claim.
Key facts
  • Sole traders and partners must pay their own pension contributions using the relief at source system with the contributions being paid from their after-tax drawings from the business.
  • Sole traders and partners can pay employer contributions for anyone they employ. These can be deducted from taxable profits as an expense of the business.
  • If a self-employed person sets up their business as a limited liability company, they are then employees of that company and can choose to pay their pension contributions either as a member contribution or an employer contribution. All employer contributions, including those paid for other employees can be deducted from the taxable profits of the business.          

Sole trader

This is the simplest form of business structure with no legal separation between the business and the individual; if the business fails, the individual is liable for all the debts of the business with no upper limit.

The individual registers with HMRC as self-employed. They then pay income tax on the taxable profits of the business and are allowed to deduct expenses of the business from those taxable profits.

Sole trader and pension contributions

A sole trader can’t deduct their own pension contributions as an expense of the business. They pay their contributions from the after-tax drawings they take. This is paid using the relief at source system, so the pension provider grosses up the net contribution at basic rate. The member then has to claim any higher or additional rate tax relief they’re entitled to through their tax return.

A self-employed individual can of course employ other people and will have to automatically enrol any eligible job-holders into a qualifying pension scheme. The employer contributions they make for their employees can be deducted from taxable profits as an expense of the business.

Partnership

A partnership is two or more sole traders, up to a maximum of 20, working together in the same business enterprise.

The partners personally share responsibility for their business. This includes:
• any losses the business makes
• bills for things they buy for their business, like stock or equipment

Partners share the business’s profits, and each partner pays tax on their share.

In a general partnership there is no legal separation between the business and the partners so again if the business fails, the partners are liable for all the debts of the business with no upper limit.

A partnership agreement is drawn up which sets out each partner's rights and responsibilities, how they run the business day-to-day and what happens if a partner dies or the partnership comes to an end.

Partners and pension contributions

Like sole traders, partners get tax relief on their own pension contributions using the relief at source system and can claim pension contributions for any employees they have as an expense of the business.

However, there are also various forms of limited partnership.

Limited partnership

A limited partnership is a partnership made up of two or more partners. It has at least one general partner who oversees and runs the business and at least one limited partner who isn’t involved in managing the business.

The general partner of a limited partnership has unlimited liability for the business’s debts, and any limited partners have limited liability up to the amount of their investment.

Partners and pension contributions

Again, the partners get tax relief on their own pension contributions using the relief at source system and can claim pension contributions for any employees they have, as an expense of the business.

Limited liability partnership

Limited liability partnerships are a hybrid of an ordinary partnership structure and a limited liability company (see below).

Unlike a conventional partnership, a limited liability partnership is an incorporated company and, as such, it’s a separate legal entity from the partners. It can own assets, borrow, lend and employ staff on its own account. As a result, limited liability partnerships must be registered at Companies House.

As with all partnerships, limited liability partnerships must have at least two partners, known as ‘members’. There can be any number of ordinary members but there must be at least two ‘designated members’ who are responsible for registering the partnership, keeping accounting records and dealing with Companies House, including sending accounts.

Although the partnership can employ staff, partners can’t be employed by the partnership.

Partners and pension contributions

Again, the partners get tax relief on their own pension contributions using the relief at source system and can claim pension contributions for any employees they have as an expense of the business.

Limited liability company

A business can be set up as a limited liability company. It’s owned by shareholders who, if the company fails may see the value of their shares reduced, possibly down to nothing. The shareholders’ personal assets aren’t at risk however.

The company has a legal identity of its own and can own assets, borrow, lend and employ staff. It has to be registered at Companies house.

A sole trader can convert their business to a limited company, owning 100% of the shares. They may think of themselves as still self-employed, but they are in fact now employed by the company they’ve set up.

Company owners and pension contributions

They have a choice of either making employer or employee contributions. Often, they’ll take a small salary and a larger amount via dividends as dividends are taxed more lightly than salary. So, if they wanted to contribute more than their salary that would have to be an employer contribution.

 

Note

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.