When you’re running a successful small business, you want to earn the rewards of your work. It’s important to retain money in the business to maintain growth and increase efficiency, but you also need to extract cash to provide a current and future personal income.
There are a number of ways to take money as personal income. These include salary, bonus, dividends, pension contributions, directors’ loans and private investments. Some are more tax efficient and some provide longer-term income, so it’s important to understand the timing and tax implications before making your decision.
In this article, we explain the options, including the latest information available on tax rates and allowances. However, these are complex matters and we would recommend taking professional advice to get the optimum solution for your personal and business circumstances.
A regular salary is perhaps the most obvious form of extracting cash for personal income. For tax purposes, you are treated as an employee of your company when you take a salary and you will pay tax and make National Insurance Contributions to HMRC on a PAYE basis.
The most efficient way to take a salary is to keep it to a minimum – below the tax-free allowance, which is £12,570 for the current year. That means you will pay no income tax on that amount. If you take more as a salary, you will pay tax at the following rates. Between £12,571 and £50,000 the rate is 20 percent. From £50,001 to £150,000, the rate is 40 percent and that rises to 45 percent on any salary above £150,001.
You will also have to make National Insurance (NI) Contributions above earnings of £9,500 per year. If you use the figure as your limit for salary withdrawals, you will avoid tax and NI contributions, but you will qualify to receive a State Pension.
An alternative to a regular salary is a one-off bonus in the form of cash or vouchers. Any cash bonus is subject to income tax and NI contributions at the same rates as salary. However, if you take a non-cash bonus, such as a company car, this may be subject to different rates of tax.
As a shareholder of your company, you are entitled to take a dividend from any profits the company makes. From a business perspective, you must decide how much of the profits to retain in the business and how much to issue as dividends. Before issuing any dividends, you must make and record the decision at a board meeting.
Dividends can be tax efficient. You can receive up to £2,000 worth of dividends in a tax year without paying income tax. Above £2,001, you pay tax at the appropriate PAYE bands. Remember, that dividend income is added to any other taxable income you have, and the total may take you into a higher tax band.
However, one advantage is that dividend payments are not subject to NI contributions, so you may be able to make savings there.
Read More: A guide to UK dividend tax rates in 2020/21
Your company can make contributions to your pension fund and make significant savings on tax and NI contributions, compared to paying you a salary. However, you will not be able to access any of the funds until you reach retirement age, so this is likely to be part of a wider strategy if you need immediate personal income.
The annual allowance for pension contributions is £40,000 for anyone earning up to £150,000 (or is it £240,000). Above the higher limit, the annual allowance is lower. The maximum contribution of £40,000 must not exceed your total income from all sources. So if your personal income is £39,000 and you received £40,000 in pension contributions, you would be liable to pay tax on the £1000 excess.
If you need funds to meet a short-term personal requirement, you can arrange a director’s loan from your business to put funds into your personal account. A director’s loan is a useful low-cost or interest-free source of funds.
The loan is treated as a form of income and is subject to tax if the loan is more than £10,000 or if you paid your company interest on the loan below the official rate set by HMRC.
You should aim to repay the loan to the business before the end of your financial year. If not, you will be liable to an additional tax charge, known as S455, on any outstanding balance.
Taking profits to invest in another private company provides you with an indirect form of income that has some tax advantages. If you invest the funds in a start-up or growing company, you may be able to earn dividends from the other business as personal income. The dividends would be subject to income tax in the normal way.
However, depending on the type of business you invest in, you (or your company?) may be able to earn tax credits through the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS).
Making the right decision about withdrawing money from your business for personal use can be complicated and time-consuming. Our team of small business accountants are highly-experienced in helping companies with professional advice that can maximise income while reducing tax liabilities.