Pensions: tax relief and long-term growth

Employer pension contributions are usually an allowable business expense, reducing profits before Corporation Tax. Unlike salaries, there are no National Insurance costs and unlike dividends, there is no need for distributable profits to receive them.  

With an annual allowance of £60,000 (tapering from £260,000 adjusted income, minimum £10,000) and the lifetime allowance abolished, the pension option has become more attractive.  

Contributions benefit from tax relief and funds grow free from Income Tax and Capital Gains Tax until retirement. Directors can usually access pensions flexibly from age 55, rising to 57 in 2028, with 25 per cent normally tax-free if within allowable limits. 

This is why they are becoming an increasingly popular vehicle for distributing profits from a company as part of a wealth plan.  

A £10,000 profit comparison 

Using 2025/26 rates for a higher-rate taxpayer: 

• Bonus: £5,096 net benefit 

• Dividend: £4,969 net benefit* 

• Pension: £10,000 in the pension pot 

*Assumes the dividend allowance has already been used and that Corporation Tax is paid at 25%. 

Even after tax on withdrawal, the pension compares strongly. Taken as a basic-rate taxpayer, £8,500 net is available, or £7,000 as a higher-rate taxpayer.  

This is 67 per cent and 37 per cent more than a bonus and 71 per cent and 41 per cent more than a dividend payment. 

The 10-year horizon 

Short-term efficiency matters, but the real advantage of pensions emerges over time. 

• Scenario 1: Dividends only – £118,500 annual profit, extracted fully as dividends, provides £80,048 net each year or £800,486 over 10 years** 

• Scenario 2: Dividends + £60,000 annual pension contribution – Leaves £50,832 net income per year but grows a pension fund to £754,673 at a fairly normal five per cent growth. This creates a combined wealth of £1.26 million in this period.  

The pension strategy delivers almost 60 per cent more wealth after a decade, highlighting the power of compounding within a pension pot.   

** assumes dividend rates don’t change during this period.  

Wealth transfer and future challenges 

Pensions have also been powerful estate planning tools, typically free from inheritance tax (IHT).  However, from 2027, unspent pensions will count towards estates for IHT purposes. 

This could push more business owners towards using dividends to extract profits earlier and diversify wealth into ISAs or other structures. 

How can we help

Taking all of this into consideration, the optimal strategy is often a mix of pensions and dividends, but every individual’s set of circumstances is different, which is why it is important to obtain professional advice.  

If you would like to know how you can incorporate your business profits into your wider life wealth planning, please get in touch with Nicholas Clark (nicholasclark@lubbockfine.co.uk).

*A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your 
investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.  Your pension income 
could also be affected by the interest rates at the time you take your benefits.