Extracting profits from your own business in the form of pension is one of the most tax-effective ways of remunerating yourself. Regrettably, the vast majority of business owners overlook this tax strategy which if implemented properly could significantly lower their tax bill.
In this article, we shall discuss some of the first questions that may come to your mind: How this tax strategy works? Why I should consider including pension contributions to my remuneration? What are the tax benefits, for me and my business? How much I will save in comparison to, say receiving a salary or dividend? How should I go about structuring a pension plan?
How pension plan works
The principle of this tax strategy lies in setting funds aside from your business into a company established pension plan (approved provident fund), from which you can subsequently draw without paying income tax. The payments into the pension plan will be those made by you and that of your business, in a proportion that meets your personal and financial needs and optimizes your business tax position. For example, among the many alternatives, you may contribute 2% of your gross salary into the pension plan, and your business 8%. Other options are also possible.
Why consider pension plan
The major benefit of including pension as part of your remuneration is that you start saving and by doing so will provide for your future needs. The second major benefit is of double nature, it minimizes yours and your business tax liability. Thirdly, you retain the flexibility to decide on the pension plan structure and customize it to your own circumstances. Fourth, this type of remuneration does not constitute insurable earnings and hence social insurance is not levied. Finally, extractions of funds can be made not only at pensionable age, as misunderstood by many.
Tax savings you could expect
As mentioned, the tax saving is twofold: yours and that of your business. Your tax-saving consists of minimizing your taxable income by the payments made to the pension plan. On the other hand, the contributions made by your business are a business expense and reduce profits which in effect lower the corporate tax liability. In most cases, the combined tax saving, yours and that of your business, will be somewhere between 50% and 60%. The tax saving compared to receiving a dividend will be at least 20%.
How to go about starting up your pension plan
Whether or not you decide to seek professional advice, that of a financial or a tax advisor, the process of employing this strategy will go though, roughly the same steps. The first step is to establish your personal and business financial position. This stage will include, assessing whether there are material benefits to include pension plan in your remuneration and how that will impact your business, now and in the future. If the benefits of using a pension fund are justifiable, the second step is to establish an approved provident fund and narrow down on the tax plan that will be employed. This phase will also comprise of setting a mandate for the pension fund and ensuring that contributions are safeguarded and safely invested. Finally, depending on your personal financial need, the available modes for extracting funds will be determined.