When to switch from sole trader to limited company - and how this affects your pension
Being self-employed offers a lot of freedom in how you work - a big reason it’s so attractive to millions of small businesses owners in the UK. Many start as sole traders and later establish their businesses as limited companies. This can mean giving up some simplicity but gaining financially through more attractive tax rules, including when it comes to pension saving.
The trick is knowing when to switch from sole trader to limited company, when not to, and how pensions could fit into the decision.
What’s the difference between a sole trader and a limited company?
A sole trader owns and runs their own business, with no legal line between you as an individual and the business. It’s usually the simplest way to start trading and most people set up as a sole trader.
A limited company is a business that's a separate legal entity from its owners, also known as the ‘shareholders’. If you’re the sole director and employee, you’re the only shareholder. A limited company has its own bank account and must keep separate business accounts.
When it could make sense to switch from sole trader to limited company
There are certain trigger points you may reach with your business that can make it sensible to move from a sole trader to a limited company.
Consistently high profits
Often, sole traders consider transitioning to a limited company when they start consistently making profits above £40,000 - £50,000 a year. At this stage, you’re getting close to paying higher rate Income Tax of 40%, which kicks in on earnings over £50,270 (2025/26).
In this case, your profits are high enough that paying Corporation Tax, drawing a salary and taking dividends could be more tax-efficient than paying Income Tax and NI on all your profits as a sole trader. These potential tax savings can make the administrative burdens that come with being a limited company worth it.
A high tax bill
A limited company lets you keep profits in the business, which can be handy in managing the amount of personal tax you pay. For example, you can take a small salary - e.g. below the Personal Allowance threshold of £12,570 (2025/26) - then use your business’s profits and pay yourself in dividends at the level you please. This can be a good idea because dividends are taxed at a lower rate than income. Although the Dividend Tax rate will rise for basic and higher rate taxpayers from April 2026.
The table below shows the Income Tax rates for 2025/26, which are currently frozen until April 2031, and the Dividend Tax rates in the 2025/26 and 2026/27 tax years:
Bear in mind that, if you have other shareholders, they’ll usually need to be paid the same dividend per each share they hold in your company as you.
You have an eye on retirement planning
Being the director of a limited company comes with some useful retirement planning advantages. Your pension contributions can be made by the company, and so are treated as employer contributions. This means they’re an allowable business expense, which:
- reduces your Corporation Tax liability (contributions are made pre-tax); and
- avoids Income Tax and NI on the contributions.
Also, you can usually tax-efficiently contribute up to the annual allowance to your pension each tax year. The standard annual allowance is up to £60,000 and you can receive tax relief on personal contributions up to 100% of your earnings, capped at £60,000 (2025/26).
But directors can also make employer contributions to their pots. So, they can pay themselves a small salary and make tax-relievable contributions on this amount. They can then make further employer pension contributions above their salaried earnings.
It’s easy to pay into a pension as a limited company director.
- open a private pension, (like the PensionBee self-employed personal pension);
- your limited company makes employer contributions directly from its account to this pension; and
- any investment returns or interest received is tax-free.
The key takeaway
Paying into a pension via your limited company is often more tax-efficient than taking a salary and paying in personally, thanks to Corporation Tax and NI savings. It can also mean you can pay higher amounts into your pension from the business beyond the salary limit that applies to sole traders.
When staying a sole trader (or switching back) may be more suitable
Despite the tax advantages of registering as a limited company, there are circumstances where it may be better for you to stay as a sole trader, or switch back to being one. For example, if you have lower or uneven profits, want to go back to a simpler way of managing your business, or need to take all your profits personally.
But what does this mean for your pension?
Will my limited company pension be affected if I switch from limited company director to sole trader?
Don’t worry, the pension pot you’ve built up so far as a limited company director will be unaffected.
Can I still contribute to my personal pension as an employer?
As a sole trader, you won’t be able to make employer contributions to your pension. This means contributions will come from your personal income - you’ll get tax relief at your marginal rate on up to 100% of your earnings, capped at £60,000 (2025/26), but no Corporation Tax or NI benefit.
Things to consider before switching from sole trader to limited company
Changing your company structure is quite a big jump for a small business. It’s often worth having a few years under your belt before deciding (though you don’t have to wait). You’ll probably want to ask yourself (and your business) a few questions, like:
- how stable are my profits;
- could moving from sole trader to limited company director save me tax;
- how much control do I want over my business;
- do I need a level of legal protection, and to limit my personal liability to the business; and
- how much do I want to contribute to my pension each year, and could I pay more in employer contributions as a director?
Also, what’s most financially important now - total access to your profits for a sole trader or the tax and pension benefits of a limited company - will probably change over time.
If you aren’t sure, consider modelling the numbers with an accountant or a qualified Independent Financial Adviser (IFA).
Final thought
Whether sole trader or limited company director, it’s important to set up and contribute to a pension as soon as possible. While cash flow can be tricky as a small business, if you’re able to put away small amounts into your pension these can add up over time. And the longer your money is invested, the more chance it has to grow and the better off you could be when you come to retire.
Laura Miller is a freelance financial journalist.
Risk warning
Please note that tax rules change regularly, and the actual tax benefits you receive will depend on your individual circumstances. If you’re not sure, please seek professional advice.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
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