If you’re running your own company, you can decide how much you pay yourself, when you pay yourself and even how you pay yourself.
But although it is your business, it is not quite your money. The wealth you work so hard to build up belongs to the business, not you. If you take money out in the wrong way, you could find yourself liable for some rather costly tax penalties.
At Continuum we are looking at ways to extract profit from your business, without giving it straight to the taxman.
Reducing your tax liability is legitimate
You must not break the rules on tax.
But there is no rule that says you must take profits out in a way that gives the most tax to the government. You are perfectly entitled to organise your affairs to pay the minimum amount of tax – as long as it’s within the rules – and at Continuum we know the ways to help.
There are three main routes for a business owner to extract profits from their own limited company: salary, dividends, and pension contributions.
Making the least of your salary
Most business owners with their own company will reduce their tax bill by paying themselves a small salary and take the other income they want as dividends.
This is because your salary will attract income tax (for tax year 2020/2021):
- Pay yourself less than the income tax threshold of £12,500 and there is no income tax to pay
- From £12,501 to £50,000 you will pay 20%
- From £50,001 to £150,000 you pay tax at 40%,
- And if you are in the position to be able to pay yourself a salary of over £150,000 per year, the taxman will share your good fortune at 45%.
Not only does a small salary mean paying less tax, it means smaller National Insurance Contributions (NIC), You pay 12% employees NIC while the business would have to pay 13.8% employers NIC on your salary.
The simple way to pay less tax and still earn £100,000 per year is to split it into a small salary – perhaps – £12500 and a £87,500 dividend.
Making the most of your Dividends
Dividends can reduce or eliminate your income tax liability, but are not tax free. You can only pay dividends on profits generated, which incur a 19% corporation tax charge, and for the current tax year (2020/21), you can take up to £2,000 worth of dividends tax-free.
How much tax you pay on dividends above the dividend allowance depends on your income tax band as shown below:
- Basic Rate – 7.5%
- Higher Rate – 32.5%
- Additional Rate – 38.1%
But remember, your dividend tax allowance could already be used up by other payments you have received. If you have investments that pay dividends, your allowance could be eaten up.
Making more of your pension
If you earn up to £200,000 per year, your company can put up to £40,000 per year in a pension plan, completely tax-free, up to a lifetime value of £1,073,100
That’s a significant amount of money in a tax-efficient fund, which has the added protection of being outside your business – and possibly out of reach of creditors if things go wrong.
But if you run a business, the possibilities don’t stop there. Small Self-Administered Schemes or SSAS pensions can let you decide how to invest your pension contributions, and that could not only be rewarding, it can let you invest in your own business. The current rules are that your SSAS can lend up to 50% of the total held to your business, making it a valuable source of additional funds. There are some restrictions. The money loaned must be a real investment, rather than an interest-free loan and must be paid back by the company with a reasonable rate of interest. However, it can be at a rate substantially below that offered by a commercial lender.
So, with an SSAS, you could potentially use your pension fund to buy your business premises or major capital equipment or fund any other business initiative that can bring an identifiable return.
Using your pension in this way carries some risk – and as always with pensions, expert advice is essential.
Getting the help you need
Naturally, the rules about tax and your business are complicated, and any steps you may want to take to reduce your liabilities will have to be taken very carefully. Having an expert at your side will be vital, and at Continuum, we can provide the expertise you need.
To talk to us about profit extraction, and how it can be integrated into your broader financial plans, contact us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment or tax strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.
The Financial Conduct Authority does not regulate taxation advice.