Extracting company profits: what are the options?

17 July 2022

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Fiona Hanrahan, Intermediary Development and Techical Manager at Royal London, explores how company directors can take profits depending on their circumstances.

Company directors have 3 main options when taking profits from their companies.  These are salary, dividends and an employer pension contribution.  Each of these options is taxed differently with regard to the company and the individual.

The current rate of corporation tax is 19%.

The current rate of employer National Insurance is 15.05% for earnings above £9,100 per year.

The current rate of employee (director) National Insurance is 13.25% for earnings between £11,908 and £50,270 and 3.25% for everything above £50,270.  The figure of £11,908 is specific to tax year 2022/23 due to the change in the National Insurance thresholds from July.

The maximum salary possible without paying any National Insurance contributions (Employer NI threshold) is £9,100.

Case study

The following case study will help show how much an individual would receive after tax and National Insurance using one of their options or a combination.  We’ll assume there is profit of £100,000 to be extracted.  The individuals are all resident in England for tax purposes.

Mrs Cynic needs income and is looking to take on a mortgage in the near future.  So, she chooses to take all of the £100,000 as salary. Her salary has been calculated so that the salary and employers National Insurance amount to £100,000.

Ms Maximiser is 60 and is looking to boost her pension savings.  She decides to pay the full £100,000 as an employer contribution into her pension and take the PCLS immediately.  She has unused annual allowance from previous years to carry forward to avoid any annual allowance tax charge. Assuming she is a basic rate taxpayer in retirement and 25% PCLS is taken, she will ultimately receive £85,000 (£25,000 plus 80% of £75,000).

Miss Spendnow is looking to maximise her immediate income as well as take enough salary to receive credit towards her state pension. The corporation tax is calculated on 19% of £100,000 less salary of £9,100.

Miss Livzalife is looking to pay the maximum into her pension without paying a tax charge.  This is £40,000 as she has no unused annual allowance to carry forward.  She would also like to receive the minimum salary to ensure she gets credit towards the state pension. She takes the remainder as dividends for her immediate income needs.  The dividend is £100,000 less salary of £9,100 and £40,000 pension contribution and the corporation tax is calculated as 19% of this.

Assuming she is a basic rate taxpayer in retirement and 25% PCLS is taken, she’ll ultimately receive £34,000 (£10,000 plus 80% of £30,000).  This reduces the amount extracted by £6,000.

We’ve put all the figures together in a table below.

Every business owner has choices to be made and numbers to be crunched which will mean the best decision based on their circumstances and need for income.  The best option or combination of options will depend on their age, their need for immediate income, their available annual allowance, their National Insurance record and mortgage situation. It’s also good to have a discussion with any accountancy connections as pensions are often overlooked, especially those for spouses in a business who have director duties. The days of large pension contributions in the year of retirement have gone, and pensions should be considered earlier to provide the best retirement outcome for your clients.

For more pensions technical information, visit Royal London’s Technical Central.

Professional Paraplanner