A common question we are asked by directors is ‘what is the best way to take income from my company?’ There is an abundance of solutions, but which is the most tax efficient?
This Tax Tuesday, we share our top strategies for extracting income from your company with minimal tax turbulence, striking the balance between salaries and dividends.
How to get an income from your company
Determining how to draw income from your company typically involves a blend of salary, dividends, and possibly pension contributions. The ideal mix depends on several factors:
- Company Profits: Your company’s financial health plays a crucial role in determining how much income you can take
- Personal Financial Needs: Consider how much income you require to cover your living expenses and support your lifestyle.
- Tax Efficiency: Different methods of income, such as salary and dividends, have varying tax implications. Choose a strategy that minimises your tax burden while maximizing your take-home pay.
- Retirement Planning: If you’re planning for retirement, you may want to prioritise contributions to a pension scheme, which can provide long-term financial security.
- State Benefits: Your choice of income structure may impact your eligibility for certain state benefits, such as income-based benefits or the state pension. It’s essential to consider how your income strategy aligns with your eligibility for these benefits.
Taking a salary as a director offers several benefits, including building up qualifying years for the state pension, making higher personal pension contributions, retaining maternity benefits, and facilitating easier access to financial products like mortgages and insurance policies. Additionally, a salary reduces the amount of corporation tax your company pays and can be drawn even if your business isn’t profitable.
However, drawbacks include both you and the company having to pay National Insurance Contributions (NICs), alongside higher Income Tax rates compared to dividends. Deciding the amount of salary to take involves considering NIC thresholds and balancing state pension eligibility with tax efficiency. Some directors opt for salaries between the NIC Lower Earnings Limit and the Primary Threshold to maintain state pension benefits while minimising NICs.
Taking dividends as income
Dividends represent a portion of a company’s profits distributed to its shareholders, often preferred by directors for their tax advantages. Unlike salaries, dividends are subject to lower income tax rates and exempt from National Insurance Contributions. Directors opt for dividends to reduce their overall personal tax liability.
While the tax-free dividend allowance has reduced to £500, the lower income tax rate at 8.75% for basic rate tax bracket can still be beneficial. However, dividends must be sourced from profits, which can lead to income unpredictability. They’re also distributed after Corporation Tax is deducted, unlike salaries which are deductible expenses.
There are potential pitfalls to consider. Mistakenly taking dividends not covered by profits can lead to repayments. Moreover, dividends don’t count as ‘relevant UK earnings’ for pension tax relief, posing limitations for retirement planning.
How can we help?
To maximise tax efficiency, it’s crucial to establish robust profit declaration processes. If you need guidance in navigating income extraction, please contact your relationship principal, email tax@haroldsharp.co.uk or call 0161 905 1616 if you’d like to discuss.