If you’re one of the many successful business owners in the UK, you’re no doubt looking for ways to maximise your income from your business profits. We take a look at some of the tax-efficient methods of withdrawing money from your business.

Key points:

  • Keep more of your profits: Learn how to pay yourself smarter – whether through salary, dividends, or pensions – so you keep more of your hard-earned profits.

  • Use tax allowances to your advantage: Take full advantage of your tax-free allowance and see how dividends can be a cost-effective way to top up your income.

  • Maximise your pension contributions: Take advantage of tax relief on pension contributions and build a solid financial future. With the annual allowance set at £60,000, there’s plenty of room to grow your retirement pot.

  • Lower your corporation tax: Contributions your company makes to your pension don’t just benefit you – they also reduce your business’s taxable profits, cutting down your corporation tax bill.

  • Invest in growth opportunities: Explore tax-friendly investment schemes like Venture Capital Trusts (VCTs) or Enterprise Investment Schemes (EIS). These can offer big tax breaks while supporting high-growth companies.

  • Get tailored advice: It’s important to work with a financial planner who understands your business and can help you make the best decisions for your income, investments, and future growth.

Dividends are taxed at a lower rate than salary and are not subject to NI contributions

Owning your own business gives you more flexibility and control over how pay yourself compared to being a traditional employee. This flexibility allows you to use specific tax rules to optimise your income.

Typically, there are three main ways to draw money from your business: salary, dividends, and pension contributions. Additionally, you can explore investment schemes that help reduce the tax paid on company profits.

However, tax regulations are complex and vary depending on your unique situation. They can also change over time, making it essential to stay informed. Before making any decisions, it’s wise to consult a financial expert to ensure your approach aligns with your individual circumstances.

Taking a salary tax-efficiently

Many business owners choose to pay themselves a salary directly into their personal bank accounts. Here’s how you can do this in a way that maximises your tax savings:

Your tax-free allowance for 2024/25:

  • You can earn up to £12,570 tax-free every year. This amount is your tax-free personal allowance.
  • If your salary falls between £12,571 and £50,270, you’re considered a basic rate taxpayer and will pay 20% income tax on this portion of your earnings.
  • For salaries over £50,271 you’re considered a higher-rate taxpayer, and are taxed at 40% on the amount over £50,271, up to £125,140.
  • Any amount over this threshold is taxed at the additional rate tax band of 45%.

By setting your salary just above the £12,570 threshold, you can fully use your tax-free allowance. This not only gives you significant tax savings but also helps you accumulate enough contributions to qualify for a full state pension in the future.

This approach ensures that you utilise your allowances effectively while planning for your retirement.

The tax saving benefits of dividends

Dividends have traditionally been an attractive option for business owners due to their lower tax rates compared to salaries and exemption from National Insurance Contributions (NICs). However, recent government measures have reduced these advantages. Notably, the tax-free dividend allowance has been significantly decreased: from £2,000 in the 2022/23 tax year to £1,000 in 2023/24, and further down to £500 in 2024/25. This reduction means that more dividend income is now subject to taxation.

  • For the tax year 2024/25, you receive a dividend allowance of £500, on which there is no tax to pay. Combined with your personal allowance, this means you can earn up to £13,070 before you start paying any tax.
  • Any dividends received above this allowance are taxed at 8.75% if your total annual income is below £50,270.
  • If your income goes above this limit, dividends are taxed at 33.75% on the amount between £50,271 to £125,140, and 39.35% for any amount over that.

Basic Rate Higher Rate Additional Rate
Salary 20% 40% 45%
Tax threshold £12,570 – £50,270 £50,271 – £125,140 Above £125,140
Dividends 8.75% 33.75% 39.35%
Tax threshold £13,050 – £50,270 £50,271 – £125,140 Above £125,140

Bear in mind that dividends are added to your salary and any other income sources, such as child benefits or other investments. Therefore, receiving dividends on top of your other income might inadvertently push your total earnings into a higher tax bracket, resulting in a larger tax bill than anticipated.

Using dividends to supplement your salary allows you to maximise your take-home pay efficiently after you’ve used up your personal tax-free allowances.

Tax efficient pension contributions

Making employer pension contributions is a good way to extract profits from your business tax-efficiently. Here’s a breakdown of how this works and what to consider:

Your annual allowance and carry forward

Whilst there’s no limit to the amount you can contribute to a pension fund each year, there is a limit to the amount you can claim back tax on, which is the lower of £60,000 or your earnings for the year (or a maximum of £3,600 if you have no earnings or earnings below this figure)..

Once you have fully utilised the current year’s allowance, if you haven’t utilised all your allowances in the previous three tax years, you can carry forward any unused amounts to increase your current year’s contributions, and claim back tax, as long as the total contribution in the current year is less than your earnings in the year.

The allowances for the previous three years are:

  • 2021/22 Tax Year: Annual allowance was £40,000.
  • 2022/23 Tax Year: Annual allowance remained at £40,000.
  • 2023/24 Tax Year: Annual allowance increased to £60,000.

So, in the 2024/25 tax year, once you’ve contributed £60,000 for that year, you can carry forward up to a further £140,000 from the previous three years, less any contributions you’ve already made in those years.

If contributions are being made by a company or employer, the same limits apply for the annual allowance and carry forward. However, instead, of being limited by your earnings in the year, they’re limited by the requirement to meet HMRC’s “wholly and exclusively” test for the purposes of the business to qualify for tax relief.

Looking ahead, the maximum potential contributions under the carry forward rules will increase as follows:

  • 2025/26 Tax Year: Up to £160,000.
  • 2026/27 Tax Year: Up to £180,000.

Your lifetime allowance

The good news is, the pension lifetime allowance was abolished in April 2024. Previously, the maximum you could save into a pension before incurring tax charges was £1,073,100.

Many people stopped contributing once they neared this limit, but with the restriction removed, you can now save more without facing additional charges. If you paused contributions due to the old limit, now might be the time to resume saving and optimise your tax benefits. Remember that the Pension Commencement Lump Sum (PCLS) is still restricted to £268,250 in the current tax year.

Tapered allowance

For high earners, the annual pension allowance tapers down as income increases.

If your total income exceeds £260,000, your allowance is reduced by £1 for every £2 earned above this threshold. This taper continues until the allowance bottoms out at £10,000 for those earning £360,000 or more.

Tax savings for your business

Employer contributions to your pension are a tax-deductible expense for your business. These contributions reduce your overall profits, thereby lowering your corporation tax liability. Additionally, employer contributions avoid National Insurance Contributions, adding to their tax efficiency.

Do bear in mind that if you decide to top up your pension with company profits, it’s important to understand that you can’t access your pension funds until you are at least 55 years old, so these funds won’t supplement your regular income immediately.

If you’re over 55, you might consider using immediate vesting pension contributions to cover your living expenses. However, this is rarely practical due to the complexities involved, such as the risk of triggering the recycling rules*. You need to consider whether it’s worth the hassle of paying into and vesting a pension every year?

It’s also essential to remember that pension funds are investments, so their value can fluctuate. There’s always the risk of not getting back the amount you invested. Consulting a financial planner is vital before making significant contributions, especially if you’re considering topping up your pension with company profits.

* The “recycling rules” refer to a specific set of UK pension tax rules designed to prevent individuals from exploiting the tax advantages of pensions by repeatedly withdrawing tax-free cash and then reinvesting it into their pension to gain further tax relief.

Investing in VCTs allows you to claim up to 30% tax relief on investments of up to £200,000

Exploring tax relief investment schemes

After considering the standard tax-saving options, you may still wish to reduce your tax bill further. If you’re an experienced investor and comfortable with taking higher risks, you could explore tax relief investment schemes designed to support early-stage companies.

Tax-efficient investment options

These schemes encourage investment in growing businesses by offering tax incentives. Some popular options include:

  • Venture Capital Trusts (VCTs): Invest up to £200,000 per tax year and claim up to 30% tax relief, provided you hold the shares for at least five years.
  • Enterprise Investment Scheme (EIS): Claim up to 30% income tax relief on investments of up to £1,000,000 (or £2,000,000 for knowledge-intensive companies) per year, with additional capital gains tax deferral benefits.
  • Seed Enterprise Investment Scheme (SEIS): Enjoy up to 50% income tax relief on investments of up to £200,000 per year, targeting very early-stage businesses.

Benefits and risks

These schemes are designed to compensate for the higher risks of investing in startups by offering significant tax advantages. They can be appealing for those seeking potential high returns while reducing their tax liability. However, it’s important to be aware of the associated risks:

  • Higher Risk: Early-stage companies have a higher chance of failure, and there’s a risk of losing your entire investment.
  • Value Fluctuations: The value of these investments can rise and fall, with no guarantee of recovering your initial outlay.

Is it right for you?

Tax relief investment schemes are best suited for experienced investors who can afford to take on higher risks and are comfortable managing potential losses. If you’re considering these options, it’s crucial to seek advice from a financial adviser to ensure they align with your financial goals and risk tolerance.

By carefully evaluating your options, you can potentially lower your tax bill while supporting innovative businesses.

Conclusion

As a business owner, you have a range of tools at your disposal to extract profits in a tax-efficient way. Whether it’s through a small salary, topping up with dividends, or contributing to a pension to secure your future, each method has its own benefits and tax-saving opportunities.

For those looking to take it further, exploring early-stage investment schemes or maximising corporation tax savings through pension contributions can provide additional advantages. However, with tax rules constantly evolving and each business being unique, it’s essential to plan carefully.

Taking the time to understand and implement these strategies can make a real difference to your bottom line – helping you keep more of your money working for you while staying compliant with tax regulations.

Get personalised advice from an Independent Financial Planner

Amber River financial planners work with businesses of every size. We offer advice on various topics, including how to extract profits from your business in a tax-efficient manner, how to protect your business, investment strategies, and more.

We take a comprehensive approach to financial planning. This means we work together with other experts like accountants, tax planners, and solicitors. Our goal is to provide you with the best advice that’s specifically tailored to meet the unique needs of your business.

Get in touch

To speak to us about the most tax-efficient ways to extract profit from your limited company call 0800 915 0000, or alternatively use our contact form here.

Business Financial Planning Business Owners Dividends Early-stage investment schemes Enterprise Investment Scheme Profit Extraction Seed Enterprise Investment Scheme Tax efficient investing Venture Capital Trusts