Money that would have otherwise gone to the taxman can boost your retirement savings, but action is needed before your company’s financial year-end.
Salaries reduce your profits and, in turn, your Corporation Tax bill, so this is the most obvious way to move cash out of your business. An alternative form of remuneration is dividend income. Historically, many business owners have preferred to receive a proportion of their pay in the form of dividend because, although taxable, NIC’s are not due; thus, dividends have often made up the bulk of income drawn from owner-managed small businesses.
However, since April 2016, directors of small or medium-sized companies adopting this approach have faced the prospect of higher tax bills. The 10% notional tax credit that compensated for the Corporation Tax already paid on profits distributed as dividends was abolished and replaced with a £5,000 annual dividend income, higher rate taxpayers pay 32.5% and additional rate taxpayers 38.1%.
These changes particularly affect directors who pay themselves a small salary designed to preserve entitlement to the State pension, Supplemented by a much larger dividend payment in order to reduce NICs. In most cases, the combination of a small salary and dividends is still going to be the better option, although the new dividend taxation rules may mean that you may pay more tax, depending on the levels of the dividend distribution.
However, there is another way of cutting your tax bill while at the same time helping with wealth accumulation. Company pension payments are deductible as a company expense and can therefore reduce liability to Corporation Tax. Additionally, under pension freedoms rules, those over the age of 55 can take the whole of their money purchase pension fund back and use the cash broadly as they wish – including up to 25% of the total fund tax-free – with the remainder subject to Income Tax.
Furthermore, for those who can look beyond immediate income needs, pensions offer genuine estate planning opportunities. regardless of whether a defined contribution pension is already being drawn or not, it can pass tax-free to any beneficiary if death is before 75. Even after 75, beneficiaries do not pay Inheritance Tax, only Income Tax at their marginal rate, and then only when the money is withdrawn from the pension.
You can add significant sums to your pension each tax year using pre-tax profits from your business. If you have not made pension contributions in the previous 3 tax years you may also be able to use the ‘carry forward’ rule to add to your pot. By taking it from the business, not only will you have reduced your company’s liability to Corporation Tax; you will also have saved Income Tax, including on dividends, and NICs (both personal and business) on those contributions.
If you are looking to plan your remuneration strategy for the 2017/18 tax year and would welcome some advice and assistance please do give us a call.