HMRC has special rules for the taxation of directors, including one for NI contributions. These can cause unexpected losses in your state pension rights. What are the special rules and what steps can you take to prevent a loss to your pension?
Don’t underestimate NI
NI contributions are often considered the poor relation to tax, but actually they can be far more important. If your NI record shows that you haven’t paid the full amount of NI due, even if you’re light by just a few pounds, you can lose a whole year’s credit towards your state pension. At current rates that can be worth up to £231 every year from the time you take your pension.
Rules for employees and directors
The rule for employees is that for each earnings period (EP), e.g. a week or month, for which they are paid above the lower earnings limit (LEL), £512 per month, they’ll receive an NI credit. Each full year’s credits buys 1/35th of the full state pension at the rate applying when they receive it. The trouble is that NI for directors is calculated using a different EP; it’s annual regardless of how frequently you are paid.
Trap. An annual EP can cause directors to underpay (or overpay) NI.
Example. Gill formed Acom Ltd in March 2019, and is a director. Acom started to trade in September 2019 and soon after Gill began to draw a low salary. Her earnings as a director for 2019/20 will be six months’ salary (October 2019 to March 2020 of £4,320 (6 x £720)). This is less than the £6,144 lower limit and so she pays no NI meaning that she won’t receive a full year’s credit towards her state pension.
Trouble with EPs
As shown by our example, trouble can arise because the annual EP for directors applies from the time they are appointed and not the time they start receiving a salary. A similar problem can occur when a director resigns part way through a year.
Example. Jane resigned as a director of Acom Ltd on 30 September 2019. Her earnings for 2019/20 up to then were £3,000, all paid in July. Acom used the alternative method to work out her NI. This can, by concession, be used to work out directors’ NI. It involves using the same EP as that for employees, but reverts to the special one for directors when they resign. The annual EP is time apportioned to the date of resignation, i.e. to £3,077 (£6,144 x 26/52). This exceeds her total salary and therefore Acom must refund the NI she’s paid, which means she won’t receive a credit to her pension record.
Always check
Where you start to pay yourself as a director for the first time, or resign your directorship part way through a tax year, check that your earnings for the year exceed the LEL (or the time-apportioned LEL) and that you’ve paid NI contributions if they were due.
Tip. If you haven’t paid contributions through your salary you can pay them voluntarily in order to obtain a credit for state pension purposes. They are called Class 3 NI contributions and for 2019/20 they are payable at the rate of £15 per week. They can be paid after the end of the tax year, but within a specified time limit.