The new tax year means that many directors of family companies will be considering the most tax efficient method of paying themselves.
For many years accountants and tax advisors have suggested that director/shareholders should extract profit by paying themselves a low salary with the remainder of their income being extracted in the form of dividends.
Although dividends are not deductible in arriving at the company’s taxable profits, they do not normally attract National Insurance Contributions (NICs). The starting point of NICs will rise to £162 a week from 6 April 2018. This is now significantly lower than the £11,850 personal income tax allowance. A salary just below £162 a week, £8,424 a year would mean no NIC would be due but would be sufficient to count as a qualifying year for State Pension purposes (if above £6,032 lower earnings limit).
Pension contributions are another way to extract profits from the company if those funds are not needed in the short term.
The company gets tax relief, it is not income in the hands of the director (until drawn as a pension at least) and 25% can be drawn tax-free upon reaching pension age.
Of course there’s an annual limit before a tax charge is incurred which is currently £40,000 – or £4,000 if you have already started drawing a pension, or drew a pension in the pas. This is tapered down by £1 for every £2 income over £150,000, to a maximum reduction of £30,000. Tapering will only apply where an individual’s income excluding pension contributions exceeds £110,000 (referred to as their “threshold income”).
The allowance can be topped up with any unused allowance from the previous three tax years, but only if the individual was registered with a pension scheme during that time, even if nothing was contributed to it.