UK State Pension Entitlements for Directors: Am I Eligible?
This is a question I have been asked many, many times:
"As a director of my own limited company am I still eligible for the Basic State Pension?"
What is the Basic State Pension?
Every UK National is entitled to the Basic State Pension on retirement; a regular payment from the government payable at pensionable age—now gradually increasing for women to bring them in line with men, age 66, by 2020. To earn full state pension entitlement you are required to have National Insurance Contributions (NICs) credits for 30 qualifying years. Currently, the most you can expect from a state pension is £110.15 per week. It increases annually in line with the Consumer Prices Index (CPI), currently at 2.5%.
Additional State Pension
The Additional State Pension is what it says; it’s paid in addition to the basic state pension. This is based on your NI contributions, and how much you get depends on your earnings and whether you’ve ever claimed certain benefits. There is no fixed amount like the basic state pension. You get the additional state pension automatically, unless you’ve contracted out of it, but we won’t dwell on this here because it will change in 2016 when government brings in the single-tier pension.
National Insurance (NI)
NI is different from income tax: first, not everyone needs to pay it; only those earning income through PAYE or who are self-employed above the age of 16 and below the statutory retirement age, pay NI. Second, payment of NI means that you are entitled to certain state benefits that are linked to your NI number. Everyone who pays NI builds up an entitlement to a state pension; unemployed people build up a fund through unemployment benefits and other benefits linked to their circumstances.
NI for the employed and self-employed
The amount of NI you pay depends on whether you are self-employed or employed and how much you earn. Self-employed NI is only for those who trade under their personal name and are registered with HMRC. Self-employed Class 2 NI contributions are paid at a flat rate of £2.70 a week, although earnings below £5,725 per year (2013–14) may mean that no NI is due. The self-employed also pay Class 4 NI on their profits at 9% between £7,755 and £41,450 and 2% on profits over that amount. The employed pay Class 1 (primary) at 12% of "taxable" income up to £42,750 after deducting various allowances.
NI and Limited Companies
Paying a minimal salary and taking the rest from the company’s profits by way of dividend is what the majority of owner-managed companies do. As the company is free to pay its directors whatever they want (directors’ income is not subject to minimum wage legislation), it makes sense to maximise the amount paid by dividend and therefore avoid paying employees’ and employers’ NI.
This is the beauty of owning your own limited company, because only employees and the self-employed pay NI, while directors receive dividend income which, as a return on your investment in the shares of the company, is not subject to NI.
How do I get state support without paying NI?
Let’s get back to the question: "As a director of my own limited company am I still eligible for the Basic State Pension?"
Yes you are: NI is not payable until employed earnings exceed £139 per week (the primary threshold), but the NI system starts for income above £102 per week (the lower earnings limit). Providing you are paid between these two amounts, you will get a credit for NI even though you have not paid a contribution either as an employee or employer. This free credit was introduced to help the low-paid build up benefits entitlements, but it’s a huge advantage for directors of limited companies.
How does it work?
When a salary of, say, £7,020 (below the lower earnings limit) is paid annually, the state pension will receive the year’s credit even though no NICs has been paid by the director or company.
If the salary level is below this amount, or no salary is paid, the pension fund will lose the credit for that year, and although it is possible to purchase voluntary NICs retrospectively for up to six years, they are purchased on a weekly basis and are expensive.
Like a large number of director-owners Eileen decides to pay herself a salary of just below the employer’s earnings threshold, which provides her with the NI contribution "credit" for the year that she requires in order to be eligible for state benefits and a state retirement pension.
As sole director and shareholder of her company, minimum wage rules do not apply, so she decides to pay herself a salary for 2013/14 of between £473 to £641 a month, which means that neither she nor her company will pay any NICs, but she will still be credited with free NICs, and continue to amass qualifying years for her state pension. By paying herself at around £5,715 per annum, she is paying NI at a rate of 0% (so long as she submits the correct PAYE returns each year). This means that each year counts as a qualifying year for state pension purposes and, providing she keeps this up for the 30 qualifying years, she will get the full basic state pension.
In summary, in terms of tax and NI, having your own limited company has huge advantages over being self-employed or employed. In addition to this, it is also more beneficial from a pension perspective. Also, a small director's salary above the LEL of £5,668 will grant you the pension contributions you require whilst costing nothing in NI payments.
As mentioned, from April 2016, the basic state pension will be replaced by the single-tier pension, but hopefully this change will not affect the way that limited company directors benefit.