This is yet another common question that we accountants get asked a lot, “What is the most tax-efficient way for me the owner to take money out of my business?”
In simple terms, there are 3 different ways that you can choose to remunerate yourself from your own business.
- Straight forward salary
- Dividends
- Pension contributions
Most directors of limited companies will pay themselves in a combination of salary and dividends for tax efficiency reasons. The best way to illustrate this is in the form of an example.
John wants to be able to take £39,500 as his earnings from his business as the owner and director.
If he was to take it all in salary, he would be required to pay income tax (at 20%) and national insurance (12%) on that amount. £39,600 less personal allowance of £12,500 which is £27,100 by 20% amounts to £5,420. In addition, he would also be required to pay national insurance. That works out at a further £3,598, so all in all a total payment to HMRC of £9,018.
If he chooses to take £9,500 (keeping his earnings below the threshold where he would be required to pay income tax and national insurance) and £30,000 in a dividend that would work out very differently. Let’s take a look.
He has a tax-free allowance of £12,500 so that means his salaried amount falls below the threshold of income tax and national insurance, therefore nothing is due.
There is a dividend allowance of £2,000, meaning that the first £2,000 of dividends are tax-free. So that means £28,000 of the dividend is taxable. The tax rate for dividends is 7.5% so that means a tax bill of £2,100. By taking a combination of a salary and dividends John has saved £6,918 in that year.
Although taking the income mostly in the form of dividends may seem like a no brainer there are certain limitations and pitfalls to be aware of
- Dividends can only be paid out of profits.
- Reliance on dividends means that your income in the year is unpredictable
- Dividends can only be taken from distributable reserves (that is after corporation tax has been deducted).
- If you accidentally take a dividend that there is insufficient profit (after corporation tax has been deducted) to cover you will by default have taken out a director’s loan which must be repaid within a defined period otherwise tax becomes due at the rate of 32.5%
We mentioned above that there was a third way to take income out of your business in a tax-efficient manner i.e., Pension contributions. This is different from contributing to your pension yourself as it counts as an employer pension contribution
The benefits of taking employer pension contributions are
- Pension contributions don’t add to your gross salary and therefore do not increase your tax bill
- They are allowable business expenses saving you 19% of that amount in corporation tax at the end of the financial year
- There are no employer NICs to pay saving an average of a further 13.6%
- Employer contributions are not limited by the size of your salary.
However, there are limitations also with this method
- There is a threshold to the amount of employer contributions per individual that can be contributed, £40,000
- Obviously, you cannot access your pension until you reach at least the age of 55
At Ekstra Accounting Solutions we want to help business owners find the most tax-efficient way to take income out of their business that also works best for their particular circumstances. We work alongside some associates who can provide expert pension advice.
If this is something that is of interest to you, please get in touch in the following ways:
Email: janet.jensen@ekstraas.co.uk Tel: 07458 302 512 Website: www.ekstraas.co.uk
If you found this article useful please let us know and please share with others whom you believe would benefit from this information.