People who start their own company often do so out of passion and pride. After all, it’s no easy ride. It’s a hands-on job, with some business owners not being able to see the financial rewards of their efforts and investments until months or even years down the line, especially for startups.
But financial security will always be a priority for the self-employed and there’s no reason for clever planning to stop when it comes to deciding how to take earnings from your limited company.
In fact, there are ways to extract profits that could reduce your tax bill. We’ll take you through some of those methods.
Taking out some of your limited company profits as a director’s salary is the most obvious way to extract profits for your personal income.
The problem is the tax you would face on the kind of salary you might feel you deserve. Given that this would be subject to income tax, you could be paying as much as 45% tax on whatever you take out of your company as pure salary.
This is why many company owners, even if they’re entitled to a salary, don’t exceed their personal allowance tariff, which is £12,570 for the 2021/22 tax year.
But even taking out the full personal allowance isn’t necessarily advisable, because your company will have to start paying employer’s National Insurance contributions as soon as your salary reaches £8,840 – the secondary threshold of class one National Insurance contributions.
Just remember that other sources of income, including savings and rental income, also counts to the £8,840 limit, as tax on wages is deducted through PAYE.
There’s the added benefit that a low salary can be deducted from your company’s profits before your corporation tax bill is calculated.
After you have taken out this rather low wage, we would recommend you top up the rest of your extraction with dividends.
Each shareholder is entitled to £2,000 of dividends completely tax-free, with any exceeding this amount falling into three tax bands:
- basic rate (up to £34,500): 7.5%
- higher rate taxpayers (up to £150,000): 32.5%
- additional rate taxpayers (over £150,000): 38.1%
You’ll notice how dividends are taxed at a lower rate than regular income, which is why they are one of the most tax-efficient ways to top-up your salary.
Be mindful, however, that you can only pay out dividends when you make a profit, while a salary can still be paid out during a period of loss.
Contributing to a pension as the owner of a limited company can also bring significant tax advantages, as your contributions can be treated as a business expense and so reduce your company’s corporation tax bill.
If you run an incorporated limited company, you have the added benefit of being able to make personal contributions to pensions or contributions through your company.
Although there is a £40,000 annual pension limit, there is no tax charge when contributions are added.
You can also access and withdraw 25% of your pension pot tax-free, with marginal rates applying after that.
Get in touch with us to discuss extracting profit from your business.