Tax-efficient ways to extract profits from your business

If you’re a business owner or director, making employer contributions to your pension from company profits not only reduces your corporation tax liability but will also boost your retirement income.

From 6 April 2023, the rate of corporation tax is increasing from 19% to 25% for companies with annual profits of £250,000 and more.

• For those with annual profits up to £50,000, the tax rate remains at 19%.
• For those with annual profits up to £250,000, the first £50,000 will be taxed at 19% and the remaining amount up to £250,000 at 25%.
• For those with annual profits over £250,000, the whole amount is taxed at 25%.

How can you extract money from your business tax efficiently?

There are a number of ways for private business owners and directors to extract money from their businesses, which are subject to different taxes:

Salary. You can take income as a salary but anything over about £9,100 will then become liable for employer National Insurance contributions and employee National Insurance over £12,570. You’ll also start paying income tax over your personal allowance, which is set at £12,570 for 2023/24.

Dividends. Paying dividends is more tax-efficient than salary for anything above that £9,100 level. But your company will have already paid corporation tax on the money and it will then be subject to dividend tax. It’s important to note that the dividend allowance is reducing over the next few years.

Pension contributions. If you don’t need the money in the immediate future or you are approaching retirement then the most tax-efficient way is for the company to make a contribution to your pension fund. It is considered a business expense so it will not be subject to corporation tax, providing the contribution passes the ‘wholly and exclusively’ test – meaning that HMRC judges it is wholly and exclusively for the employer’s trade or profession.

Pension contributions could even lower the overall corporation tax rate your company pays if your profits are around the £250,000 cut-off point for the new 25% rate.

The rules and thresholds for all the different taxes related to company profits and personal income are complex, which is why it is important to work with your accountant and Financial Planner together.

Do you see your business as your pension?

Many business owners think about their business as their pension with only vague plans for the future, which could leave them vulnerable to the unexpected. For example, the recent Covid pandemic and the cost of living crisis reminds us how profitable businesses and sources of revenue can suddenly vanish. There is also the risk that you won’t be able to sell your business when you want or get a price that will be enough to fund your retirement plans.

Making pension contributions is a great way to transfer the profits in your company to your own name. It will give you more flexibility later about how you use the money as well as greater security. Additionally, with 25% of your pension available as tax-free cash (capped at £268,275) with the remainder subject to income tax in the year that you withdraw the income, it could be more tax advantageous in retirement and mean a greater level of wealth by leveraging the benefits of a pension.

The new pension allowance limits mean you can contribute up to £60,000 a year into a personal pension. In addition, the removal of the lifetime allowance and the associated death benefits makes it a compelling vehicle to use to build wealth for retirement.

 Forward thinking for your retirement

When it comes to deciding the most tax-efficient ways to extract money from your business, think about purpose and intent, as well as timing.

Do you need the money now or can you afford to save it for later? It is worth considering the wider plans for your wealth if you are approaching retirement age. What is right for you will depend on your situation and factors including what your plans are for life after you have stopped working and earning.

At W1M, we have the experience and expertise to advise you when it comes to building and delivering financial plans for business owners.

 Key takeaways

• From 6 April 2023 the rate of corporation tax is increasing from 19% to 25% for companies with annual profits of £250,000 and more.
• There are a number of ways for private business owners and directors to extract money from their businesses, which are subject to different taxes.
• If you don’t need the money right now or you’re approaching retirement then the most tax-efficient way is for the company to make a contribution to your pension fund.

Case study

Mrs Brown runs a successful business and over the last couple of years the profit has increased to £300,000. After forecasting the business needs for the next couple of years, there is excess capital available to be distributed of £100,000 in additional to their typical annual earnings of £90,000 (made up of salary and dividends).

Fortunately, Mrs Brown is in a good financial position and does not require the capital for personal use and is interested to explore the available opportunities to mitigate both personal and company taxation. Mrs Brown has previously invested into a personal pension, but the last contribution was made several years ago.

Having been introduced to W1M via her Accountant, we concluded that Mrs Brown could carry-forward her previous three years of unused Annual Allowance (totalling £120,000) plus her £60,000 Annual Allowance in the current tax year. Therefore, the company can contribute the full £100,000 into the pension within the available allowances. Plus, there is still £80,000 of available pension carry forward allowance in the next two years.

As a result, Mrs Brown gained a further £100,000 in her own name to go towards building and securing her financial future without any immediate tax liability and the business reduced its tax liability by 36% (£25,946).

Had Mrs Brown elected to pay the £100,000 as a dividend instead, the net benefit to Mrs Brown would be £56,961 after paying £43,039 in dividend tax. Additionally, as dividend is not treated as a business expense the extra dividend is subject to £25,000 in Corporation Tax.