How to extract money from your business tax efficiently

Owning a business often means investing no small amount of time, effort and perseverance in the pursuit of achieving the best outcomes in your chosen field. This means that business owners often don’t have the time, resources or knowledge to ensure they are effectively managing their own finances and extracting cash from their business tax-efficiently.  

There are several ways business owners can be tax efficient about the way they extract their income, and in the absence of seeking advice here are just a few. Although it should be noted that consulting an independent financial adviser may be helpful in ensuring the best financial outcomes. 

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Paying yourself an income 

The first and most common method of accessing cash within your business, is to pay yourself a salary. Every person in the UK, who has taxable earnings below £100,000, is entitled to a personal allowance of £12,570 pa (which is tax free). The next £37,700 would fall into the Basic Rate band, at 20%, with any additional earnings, up to £125,140, taxed at the Higher Rate of 40% and any excess falling into the Additional Rate Band of 45%. As noted above, any earnings between £100,000 and £125,140 will result in the gradual loss of the personal allowance and results in an ’effective’ tax rate of 60%. Drawing a salary from your business will typically incur employee and employers’ national insurance contributions, however the salary can be deducted as a business expense when assessing your corporation tax liability.   

The alternative method of drawing an income is through dividends. Although these are classed as income, they are taxed at reduced rates and have a separate Dividend Allowance of £500 pa. Dividends are taxed at a rate of 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. Although at face value, these rates appear far more attractive than the standard income tax rates for a salary, it is important to note that dividends are not a deductible expense, and these are therefore paid after the deduction of corporation tax (19%-25%).  

The most tax efficient way of drawing money from your business as an income will typically vary based on your individual circumstances. If you own your own business, please get in touch for a free initial consultation with one of our independent financial advisers to discuss your personal requirements.  

Employer pension contributions

Now that we have considered the main options for extracting capital from your business via an income, we can now consider the options for tax efficient savings that can be made as a business owner. Typically, an employed person would benefit from a personal contribution with tax relief from the government, as well as a minimum employer contribution of 3%, although many schemes do have higher employer contributions (subject to auto-enrolment conditions).

Typically, any personal tax-relievable contributions  are limited to the higher of 100% of UK relevant earnings or £3,600.

However, total contributions from all sources  are assessed against the Annual Allowance (including carry forward) with a tax charge applying to any excess.

Corporation tax savings 

As a business owner, you can make an employer pension contribution into your own pension, which gains tax relief by way of an allowable expense to offset against your corporation tax liability. Corporation tax is levied at 25%. If the company makes a £10,000 pension contribution into your workplace pension, you will receive 25% tax relief (depending on the company's profit level) on that contribution by way of writing off this pension contribution against your profits, resulting in a corporation tax saving of £2,500 (25% of £10,000).  

National Insurance savings 

Employer contributions are not subject to National Insurance Contributions (NICs). If a business owner takes the money as a salary, it attracts both employee and employer NIC (at 8% on earnings between the primary threshold and upper earnings limit, and 2% above this for employee NICs or 13.8% employer NICs).   

Therefore, using the same example as above, making a £10,000 pension contribution through the company, would save £1,380 in NICs instead of paying it as a salary, as well as a savings in employee NICs dependent on their income at the time. If you are unsure if you could benefit from the above then please get in touch.

Utilise carry forward 

In addition to these advantages as a business owner, you can carry forward any unused annual allowance from the previous 3 tax years. This means, if you haven't fully utilised your annual allowance in any of the previous 3 tax years, you could make for a large lump sum contribution into your workplace pension as well as the aforementioned tax advantages. It should be noted that personal tax-relievable contributions are always capped at 100% of UK relevant earnings in the current tax year.  Prior to utilising carry forward, you should contact a financial adviser. 

Combined tax efficiency example 

Suppose the business owner’s company makes a £60,000 pension contribution on their behalf (please note the corporation tax rate is dependent on the level of profit of the company).

Corporation Tax saving:

 The company’s taxable profit is reduced by £60,000, saving £15,000 in corporation tax* (25% of £60,000).

*The rate of corporation tax depends on the type of company and profit levels.

NICs saving:

Avoiding paying this £60,000 as salary saves £8,280 in employer NICs (13.8% of £60,000). It also avoids employee NICs which would have been 8% up to the upper earnings limit and 2% above that.

Tax-free growth: 

The pension contributions grow in a tax-advantaged environment, meaning the investment returns within the pension are not subject to Income Tax or Capital Gains Tax, much like an ISA!

Efficient withdrawal: 

Upon retirement, 25% of the pension pot can be taken tax-free (within allowable limits and subject to the Lump Sum Allowance), with the remainder subject to Income Tax, which can be managed based on the individual's tax band at the time. Please note it is important to understand your pension flexibilities, which we can help with, so please do get in touch.  

Finally, there is an option for extracting money from a company if the business is being wound up. In this instance, the company cash and assets can be extracted and will attract Business Asset Disposal Relief which will only attract 10% tax. This is typically a complex advice process which would require the assistance of an accountant. However, if you are a business owner and looking to exit, please get in touch to see how we can help with the complexities of selling or exiting a business.

If you’re looking to extract an income from your business and you’d like to seek advice, please get in touch to see how we can help. 

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The Financial Conduct Authority do not regulate tax planning.

This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. 

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available.  Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.