Salary vs dividends: what works best for business owners with growing profits?

A director’s remuneration strategy might include pension contributions, repayment of money previously lent to the business and, in some circumstances, interest on directors’ loans.

Paul says directors who put money into their company during its early years sometimes forget that those loans could later form part of the discussion.

“If a director has put money into the company, there may be loans that can be repaid. There can also be circumstances where the company pays interest on those loans. So you need to look beyond salary and dividends and consider everything that’s available.”

Employer pension contributions could also play a role. For a profitable company, they may provide a tax-efficient way of moving money from the business into long-term retirement savings.

But Neil says you also need to think about when you might need that money. “Putting money into a pension might look very attractive from a tax perspective, but the financial planner has to overlay that with the individual’s actual position. How old are they? What do they need the money for? What are they trying to achieve?”

Pension savings are generally inaccessible until minimum pension age, currently 55 and increasing to 57 from April 2028 for most people. So if you’re expecting to move home, support your children or need capital for something else, putting too much into a pension could restrict your options.

Sometimes, leaving money in the company could also make sense. A growing business might need cash for investment, recruitment or expansion, so taking more out isn’t necessarily the priority.

Neil gives the example of somebody putting significant sums into pensions while also planning for other large expenses: “You can put a lot of money into a pension and get very excited about the tax efficiency. But if you suddenly need £100,000 to move house or help your children, you can’t simply take it back out again.”

An independent financial planner can use cashflow modelling to look at expected spending, retirement plans, property purchases and family commitments and help establish how much might genuinely be surplus to shorter-term needs.

The answer could still be a larger pension contribution. But it’s been considered alongside the things you’re likely to want the money for.

Business owners can run into problems when salaries or pension contributions are paid to spouses or other family members.

There may be perfectly legitimate reasons for family members to work within a company, but Paul and Neil both say their overall remuneration needs to make sense for the work they actually do.

Paul explains: “HMRC can look at the total remuneration package – salary, pension contributions and other benefits – and ask whether it is commercially reasonable for the job the person is actually doing.”

So paying a substantial salary or employer pension contribution to somebody carrying out a relatively limited role could attract scrutiny.

Dividends are different because they arise from share ownership rather than the work somebody does for the company.

The way your company is set up can also affect how much flexibility you have when paying dividends.

Paul explains that different share classes, sometimes known as alphabet shares, can allow different levels of dividend to be paid to different shareholders.

“If everybody owns the same class of share, you can be quite restricted because dividends normally have to be paid in proportion to those holdings. Different share classes can provide much more flexibility.”

This can be relevant where more than one family member owns shares in the business and their circumstances or income needs are different.

Alphabet shares gained a poor reputation historically because some arrangements were used to reduce employment taxes, including employer National Insurance. But Paul says they can still have a legitimate role where there’s a sound commercial reason for the structure.

It’s another example of why deciding how to take money from a company isn’t always just a question of salary versus dividends. The company’s ownership structure can shape the options available, so it may be worth reviewing that structure alongside the wider remuneration strategy.

Paul and Neil often approach the same issue from different directions and it’s this teamwork that really benefits clients. The accountant might first spot something in the company accounts: growing profits, increasing tax liabilities or scope for an employer pension contribution.

Paul explains: “We can identify that there may be an opportunity to make pension contributions and reduce the company’s tax bill. But then we hand that over to Neil, because he needs to establish whether that actually makes sense within the client’s wider financial plan.”

Neil will then consider the client’s pensions, investments, spending needs, retirement plans and family commitments alongside longer-term goals. For example, plans to retire, move home or sell the business in a few years’ time could influence the decisions being made within the company today.

Neil says clients benefit when their advisers speak directly to each other. “The client shouldn’t have to understand where one adviser’s job ends, and another one starts. If we can speak directly to the accountant or other professional advisers, send the information they need and work together, the client gets a much more complete service.”

Paul agrees: “None of us has every skill set. The important thing is that the client has trusted people around them who can bring those different areas together.”

A remuneration strategy that worked when your company was smaller might become inappropriate as profits and cash reserves grow.

It’s also worth considering where you are personally. Someone investing heavily for growth could have very different priorities from somebody approaching retirement or starting to think about selling the business.

Remuneration would normally be reviewed at least annually, but some changes might prompt an earlier review. That could include new tax or pension rules, a significant rise in profits, changing personal income needs, or a shift in your plans for the business.

Taking a longer-term approach to tax planning for high earners and business owners can also help ensure today’s decisions support your future financial goals.

As Neil explains: “You need to keep looking at where the client is in their life. Their circumstances will change, the business changes and legislation changes, so what was right a few years ago might not be right now.”

If you’re starting to think about selling or winding up the company, for example, the conversation may need to widen beyond salary and dividends to include issues such as Business Asset Disposal Relief, how money is extracted from the company and the tax implications of a future liquidation.

There isn’t one approach that will suit every company director.

It might help to consider:

• How much money do you actually need personally?
• How much cash does the business need to keep?
• Are there any large personal expenses coming up?
• Are you building wealth outside the business?
• Could pension contributions form part of the picture?
• Where is the business heading over the next few years?
• Are you still growing the company, or starting to think about retirement or an exit?

As your business and personal circumstances change, the answers to those questions might change too.

And because these decisions can cut across tax, the company and your wider life goals, it will help if your accountant and independent financial planner are working as a team, on your behalf.