Extract profits from your limited company using this powerful 3-way tool.

Extract profits from your limited company using this powerful 3-way tool.

How do you extract profits in the most tax-efficient way?

Running a small business is rewarding, but navigating the world of extracting profits tax-efficiently can be a minefield. You will learn how to pay yourself through a combination of salary, dividends, and pensions, all while minimising your tax burden.

This article dives into the world of remuneration for UK limited company directors, exploring the options of salary, dividends, and pensions. We’ll unpack the tax implications for each, the impact on your company’s finances, and how to navigate this process fairly if you have multiple shareholders.

By the end, you’ll have a clear understanding of how to strike the perfect balance between maximising your income and minimising your tax burden.

Why consider a balanced approach?

A limited company offers flexibility in how you take your earnings. 

Solely relying on salary means missing out on potential tax advantages of dividends. Conversely, focusing solely on dividends overlooks the benefits of salary for building your National Insurance record and qualifying for state benefits. 

Finding the right balance is key.

Here’s why considering a mix of options is beneficial:

extract profits
Finding the right balance

Tax Efficiency

Salary, dividends, and pensions each have different tax treatments. Combining them allows you to optimise your overall tax bill.

National Insurance (NI) Savings

Salary attracts employer and employee NI contributions. By utilising dividends and pensions, you can potentially reduce your overall NI burden.

State Pension Entitlement

Taking a minimum salary ensures you continue to qualify for National Insurance credits and build entitlement towards the state pension. A link to the UK Government state pension page is here. You can use this to find your individual forecast.

Profit Retention

Leaving some profit in the company allows for future investment and growth.

extract profits
Salary, dividends, pensions

The Three Pillars of Remuneration

Salary

This regular income you pay yourself is subject to income tax and National Insurance contributions (NICs) for both you and the company. However, it allows you to build National Insurance credits for state benefits and qualify for a company pension scheme.

Example: Let’s say you pay yourself a salary of £25,000. You’ll pay income tax depending on your tax bracket (basic, higher, or additional rate) and National Insurance contributions.

Dividends

These are payments made to shareholders from a company’s post-tax profits. Unlike salary, they don’t attract National Insurance contributions for you or the company. There’s also a dividend allowance of £500 for the 2024/25 tax year, meaning the first £500 of dividends are tax-free.  However, dividends are taxed progressively, with higher rates applying to larger amounts.

Example: Imagine your company has £20,000 in profit after tax. You can choose to pay yourself a dividend of £10,000. You’ll pay dividend tax on the remaining £9,500 after deducting your dividend allowance.

Company Pension Contributions

The company can contribute to a registered pension scheme on your behalf.  These contributions are tax-deductible for the company, lowering its corporation tax bill. There are also personal tax benefits, with contributions typically receiving income tax relief at your marginal rate.

Example: The company contributes £5,000 to your pension. This £5,000 is deducted from the company’s taxable profit, reducing its corporation tax liability. You also receive tax relief on the £5,000 contribution, further reducing your tax burden.

Finding the Optimal Mix

The ideal combination depends on your specific circumstances. Here are some key factors to consider:

Your Profit Level

If your profits are low, salary might be more beneficial to build National Insurance credits. With higher profits, dividends become more attractive.

Your Tax Bracket

If you’re in a lower tax bracket, maximising salary might be better. Higher earners might benefit more from dividends due to the dividend allowance.

State Benefit Entitlement

Salary ensures you qualify for some state benefits like Statutory Sick Pay.

Retirement Planning

Company pension contributions offer excellent long-term benefits.

Sharing the Pie Fairly. Multi-Shareholder Considerations

When there are multiple shareholders, it’s crucial to ensure a fair and transparent approach.  Here are some tips:

extract profits
Share the pie with multiple shareholders

Clear Remuneration Policy

Establish a formal policy outlining salary, dividend, and pension contribution guidelines for all directors/shareholders.

Proportionate Distribution

Consider basing remuneration on shareholding percentages or pre-defined ratios.

Open Communication

Maintain open discussions with all shareholders about the company’s financial health and planned profit distribution.

Taking Action – Key Next Steps

 

Review Your Current Remuneration Structure

Analyse your current salary, dividend, and pension arrangements to assess if they align with your goals.

Seek Professional Advice

Consult a qualified accountant specialising in small businesses. They can provide personalised guidance based on your company’s financial health and your specific needs.

Develop a Remuneration Strategy

Based on your accountant’s advice and your individual circumstances, create a  remuneration strategy that optimises tax efficiency and aligns with your long-term plans.

You may also enjoy reading...

extract profits

Extract profits from your limited company using this powerful 3-way tool.

How do you extract profits in the most tax-efficient way? Running a small business is rewarding, but navigating the world of extracting profits tax-efficiently can ...
Growth Shares or share options

Want to keep key people? Growth Shares might be the answer

Growth shares offer a flexible and tax-efficient way to keep your top talent motivated and invested in your company's success. So, if traditional share options ...
Tax Season

Tax Season: Ditch the deadline dash

An inevitable climb, but surely one that can be tackled with grit and determination. There's a secret to making that ascent far less stressful and ...
Service profitability

How to make profitable services focusing on 5 simple steps

How to make profitable services focusing on 5 simple steps. Running a profitable service-based business that runs like clockwork with healthy profit margins can be ...

Make use of our financial tools...

Calculate Business
Profit

Calculate Business
Value

Salary and Dividend Combination Tool