As a business owner, you have many options when it comes to extracting profits from your company. The two popular methods are salary and dividends, most of which will use a combination of drawing income up to the personal allowance and the rest as dividends, as they are subject to differing tax rates.
The above are quite rightly viable solutions as you need an income to live your life! However, your business may have profits that are greater than the level of income you require, and you therefore face the question of what to do?
You could draw the excess as dividends, which depending on your other income would be taxed at 8.75%, 33.75%, or 39.35%. You could draw a higher salary, but this is unlikely on the basis it would be taxed at either 20%, 40%, or 45% and require National Insurance contributions to be paid.
With the freezing of the personal allowance and the reduction of the dividend allowance, you are effectively already paying more tax simply to maintain your current income, let alone drawing more.
One option is to make pension contributions from the business. This is beneficial as the contribution is made before the profits and subsequent corporation tax calculation; thus, you could immediately save between 19% to 25%. Under current legislation you could contribute £60,000 each tax year (possibly more if you have unused allowance from previous tax years).
Furthermore, monies held in a pension can be invested to grow tax efficiently, with any capital gains and income generated whilst in the pension not being subject to tax.
By funding a pension, you are investing in your retirement (presuming you do want to step away from your business at some stage), which can subsequently be drawn on as required or form a key part of your financial plan for legacy
Many business owners will argue ‘my business is my pension’, feeling that they could ‘sell up’ in the future and live from the proceeds. This may well be the case, however if someone were to advise you to invest your retirement/generational wealth in a single unlisted company, it would be a high-risk strategy. The impact of you not achieving the sale price you require means you will have to change your lifestyle or make compromises in your retirement, just at a time you don’t want to be compromising. After all, running a successful business will have meant you have made compromises throughout.
By having funded a pension over many years of you running your business, you have effectively accrued another ‘asset’ to utilise to meet your financial and retirement goals and mitigated your corporation tax liabilities. Hopefully, you do sell your business for a sizeable sum, and you can live from the proceeds - a fantastic outcome! But you could also have a large pension pot alongside the sale proceeds, giving you flexibility over how you meet your expenditure needs and allowing you to consider Inheritance Tax planning. Pensions have the benefit of being outside of your estate for Inheritance Tax calculations, and therefore a useful tool to assist with passing wealth onto your spouse, future generations, or chosen beneficiaries when you pass away.
We can take the efficiencies a step further. If your business operates out of a commercial property, you could consider purchasing this through your pension. The benefits are that, whilst the business will still need to pay rent, it is being paid into an asset (your pension) that will ultimately benefit you or your beneficiaries. Alternatively, you might already be the landlord and receive the rent from the business, however, the rent is subject to income tax at your marginal rates. Conversely, where the rent is received by a pension, no income tax is due, and it doesn’t impact on the amount you can contribute to a pension in a given tax year.
The rental income received by the pension could then be invested into a suitable investment strategy to target further capital growth over the long term and create liquidity within your pension pot should you require access to a lump sum.
To summarise, where your business has generated high levels of profit which exceed the amount you require to live on, or you do not wish to have it subject to high levels of tax, you should consider making pension contributions. Where your business operates out of a commercial property, it could make sense for you to consider purchasing this through your pension, with the benefit that your pension will receive the rent, further boosting your retirement provision and how much you can extract from your business.
There are various other considerations, such as making large contributions if you have unused annual allowance from previous tax years, inheritance tax planning, retirement planning and ultimately your exit strategy from your business.
These points will be specific to your own circumstances and objectives therefore, should you wish to discuss your options or how you are affected CLICK HERE to get in touch