It’s a loaded question, there’s never a better time to be planning than now. Taking the rare break you might get over Christmas to structure your income and tax liabilities is a wise move. First, the big question; salary or dividends?
The main benefit of drawing dividends from your business is that they are not subject to National Insurance deductions. You also have greater flexibility and are able to declare them at the most tax-efficient time. The vast majority of business owners will pay themselves a combination of a small salary and dividends, but what level might be right for you?
Salary vs dividends
Now, it’s important to remember that after the 2018 Budget the Income Tax personal allowance, your tax-free salary entitlement, is going to change in the next tax year. Currently, in 2018/19, it is £11,850, but this is set to rise to £12,500 in April 2019. The higher rate threshold is also increasing from £46,350 to £50,000. When planning your most tax-efficient income, paying a salary equivalent to your personal allowance is often the simplest, most tax efficient method.
However, there are a number of considerations to take into account when planning your remuneration:
- If you’ve only recently gone into business, or if you have other income sources, you must take any salary already earned into All salaried income within a tax year counts towards your personal allowance.
- The personal allowance is reduced if you earn over £100,000. For every £2 over this figure, the allowance is reduced by £1. Therefore, those earning £123,700 or more will not get any personal allowance.
- Your business will have to pay 13.8% Employer’s National Insurance Contributions on all salaries in excess of £162 a week, in addition to the employee having to pay 12% National Insurance. Currently, the Employment Allowance allows eligible businesses to reclaim up to £3,000 in Employers’ NICs. However, company directors who receive small salaries will not benefit unless they earn £8,424 or more. In addition, you cannot claim the allowance if you are a sole director, and have no other employees (from April 2016 onwards). It’s important to consider that the level of National Insurance you pay may affect your state pension entitlement.
Don’t forget pension contributions
The Annual Allowance (the maximum you can pay into a pension annually without paying tax) is capped at the equivalent of your ‘relevant UK earnings’, up to a maximum of £40,000. The definition of relevant earnings is an important consideration for business owners, as it doesn’t include dividends, which as we know, are often the most tax-efficient way of drawing an income.
Therefore, you can either increase your salaried income (and Income Tax and National Insurance liability) or increase your employer contributions. The latter being the most attractive option, as employer contributions are not capped by the relevant earnings rule, meaning you can contribute your whole £40,000 allowance via the business.
Benefits for the business
A personal pension will usually invest in a number of funds, aligned with the level of investment risk you are willing to take. But certain pensions, such as Self Invested Personal Pensions (SIPPs) and Small Self-Administer Pensions (SSASs), have wider investment options that might be particularly attractive to you.
Naturally, the main benefit in taking full advantage of pension allowances is potentially increased income in retirement. However, as a director, there are other incentives;
- Employer contributions are an allowable business expense that can be offset against corporation tax. You also don’t pay National Insurance.
- Thanks to Pensions Freedoms, access to your pension fund is now unrestricted after age 55
- Upon your death pensions are usually free from inheritance tax
- Should the business unfortunately fail, pensions are protected from creditors
- SIPP and SSAS arrangements can be used to fund the purchase of commercial property
- SSAS permit a secured loan back to you as the employer, which can be used to fund business activities and assets beyond the purchase of property
The level of tax-efficient income you are able to draw from your business does depend on your personal circumstances and the setup of your business. Whilst there is never a better time to consider your tax planning if you’d like bespoke financial advice from Chartered financial planners, we are always available to help.