With most unused pension funds set to be included in estates for inheritance tax purposes from 6 April 2027, business owners could reasonably question whether pensions still deserve a place in their profit extraction plans.
The answer starts with their purpose. A pension should primarily fund your retirement, not your children’s inheritance.
The inheritance tax changes undermine the argument for leaving pensions untouched while spending everything else. They do not remove the advantages of using company profits to build a retirement fund.
That distinction matters, particularly as the alternative of accumulating wealth within a company for a low-tax sale has become considerably less attractive.
The old “leave it in the company” strategy
For years, owner-directors could opt to take only the income they needed, pay corporation tax on excess profits and retain the balance within the company. Cash would accumulate alongside the business’s underlying value, ready to be extracted through a future share sale or qualifying liquidation.
The attraction was Entrepreneurs’ Relief: qualifying gains could be taxed at just 10%, rather than facing the higher personal tax cost of regular dividends.
Corporation tax had already been paid on retained profits, so this was never a 10% total tax strategy. Nevertheless, the low personal tax charge on selling or winding up the business made it appealing.
The calculation has changed. Entrepreneurs’ Relief, now replaced by Business Asset Disposal Relief, had its lifetime limit on qualifying gains cut from £10 million to just £1 million in 2020. Its rate rose to 14% in April 2025 and 18% in April 2026. Gains outside the relief can face CGT at 24%.
Retaining profits can still make sense, particularly where the business needs capital. But accumulating surplus wealth solely in anticipation of favourable CGT treatment deserves a rethink.
Your retirement should not depend entirely on finding a buyer, achieving the right valuation and qualifying for whatever tax treatment happens to apply when you sell.
Why employer pension contributions stand out
A company contribution to a registered pension can normally be deducted when calculating taxable trading profits, provided it meets the “wholly and exclusively” business-purpose test.
The money goes directly into your pension, without first becoming salary or a dividend. There is normally no income tax or National Insurance charge on that contribution.
Unlike personal contributions, employer contributions are not restricted by the director’s salary, although annual allowance rules still apply. That distinction matters for owners taking a relatively small salary alongside dividends.
Pension investments can also grow free of UK income tax and capital gains tax within the pension.
Withdrawals are usually partly taxable. The opportunity is to secure relief now and plan withdrawals around your future income, rather than automatically taking more taxable income today.
Watch the £100,000 threshold
Profit extraction becomes particularly sensitive when your adjusted net income exceeds £100,000.
Your personal allowance tapers by £1 for every £2 above that threshold, disappearing entirely at £125,140. For salary income in England, Wales and Northern Ireland, this creates an effective 60% marginal income tax band before National Insurance. Scottish rates differ, while dividend-heavy income requires its own calculation.
Taking an employer pension contribution instead of additional salary or dividends can help avoid increasing personal income into this band.
Separately, eligible personal pension contributions can reduce adjusted net income and restore some or all the allowance. A company contribution does not simply cancel out personal income already received.
Access does not mean stopping work
Pension savings are normally accessible from 55, rising to 57 from 6 April 2028, subject to scheme rules and exceptions. You do not have to retire to access them.
For owners expecting to work beyond that age, the concern about money being “locked away” may therefore be less significant.
Crucially, taking “tax-free cash” is different from drawing taxable income. A pension commencement lump sum, or PCLS, is normally up to 25% of the benefits accessed, subject to your available lump sum allowance – usually up to £268,275 across your pensions.
Taking only some or all of your PCLS and leaving the remaining funds invested in drawdown creates no income tax charge on the lump sum and does not trigger the Money Purchase Annual Allowance.
Taking taxable flexi-access drawdown income does trigger it, restricting future tax-efficient defined contribution pension savings to £10,000 a year, including employer contributions.
If your business is still providing sufficient income, there may be little reason to add taxable pension withdrawals on top. Tax-free cash can be considered separately, without unnecessarily restricting future contributions.
Fund retirement first, plan the legacy separately
The standard pension annual allowance is currently £60,000, although it can be lower. Eligible unused allowances from the previous three tax years may provide additional scope.
Contributions must also leave sufficient cash for working capital, investment and contingencies.
The inheritance tax changes make legacy planning more important, but they should not obscure the central question: how will you pay for life after work?
A pension remains a tax-efficient way to move profits out of your company and build a retirement fund beyond the business itself.
Save into it with a plan to use it. What you hope to leave behind deserves a separate conversation.
Tax treatment depends on individual circumstances and may change. Investments can fall as well as rise. This article provides general information, not personalised advice.
Key takeaways
- A company contribution to a registered pension can normally be deducted when calculating taxable trading profits, meaning the company pays less corporation tax. Unlike salary or dividends, the money goes directly into the pension without triggering income tax or National Insurance on the way in.
- Employer pension contributions are not restricted by the director’s salary, and do not trigger the money purchase annual allowance. The standard annual allowance is currently £60,000, with eligible unused allowance from the previous three tax years potentially available to carry forward.
- When adjusted net income exceeds £100,000, the personal allowance tapers by £1 for every £2 above that threshold, disappearing entirely at £125,140. Taking an employer pension contribution instead of additional salary or dividends can help keep income below the threshold and preserve the personal allowance.
- Pension savings are normally accessible from age 55, rising to 57 from 6 April 2028. Taking only the pension commencement lump sum – up to 25% of the fund, tax-free, subject to a lifetime limit of £268,275 – does not trigger the money purchase annual allowance, leaving the remaining fund in drawdown without restricting future contributions.
- The inheritance tax changes from April 2027 make legacy planning more important, but they do not undermine the core case for pension saving. A pension remains a tax-efficient way to move profits out of a company and build a retirement fund. What you hope to leave behind deserves a separate planning conversation.
