How to efficiently take money from your business through salary, dividends and other tax efficient mechanisms

As a small business owner in the UK, determining the most tax-efficient method to extract profits from your company is crucial for optimising your personal income and ensuring compliance with tax regulations. The primary avenues for withdrawing funds are through a combination of salary, dividends, and pension contributions. Each method has distinct tax implications and benefits. This guide outlines strategies to help you navigate these options effectively.

1. Salary: Establishing a Tax-Efficient Baseline

Paying yourself a salary is a fundamental approach, as it is considered an allowable business expense, thereby reducing your company’s Corporation Tax liability. To optimize tax efficiency:

• Set a Salary at the National Insurance Secondary Threshold: For the 2025/26 tax year, the National Insurance (NI) Secondary Threshold is £5,000 annually. Setting your salary at this level means neither you nor your company will incur NI contributions, while still qualifying for state benefits. This approach ensures that your salary is below the NI Primary Threshold (£12,570), avoiding employee NI contributions. 

2. Dividends: Leveraging Profit Distribution

Dividends are distributions of your company’s post-tax profits to its shareholders and are taxed differently from salaries:

• Dividend Allowance: Each individual has a tax-free dividend allowance (£500 for the 2025/26 tax year). 

• Tax Rates on Dividends: Beyond the allowance, dividends are taxed at:

• 8.75% for basic rate taxpayers

• 33.75% for higher rate taxpayers

• 39.35% for additional rate taxpayers

It’s important to note that dividends are paid from profits after Corporation Tax, so they don’t reduce your company’s taxable profit. However, they are not subject to National Insurance contributions, making them a tax-efficient method of profit extraction. 

3. Pension Contributions: Planning for the Future

Contributing to a pension scheme is a highly tax-efficient strategy:

• Employer Contributions: Your company can make pension contributions on your behalf, which are deductible business expenses, reducing the company’s Corporation Tax liability. 

• Annual Allowance: The standard annual allowance for pension contributions is £60,000. Contributions within this limit receive tax relief, and unused allowances from the previous three tax years can be carried forward, subject to certain conditions. 

It’s essential to ensure that pension contributions are within the allowable limits to avoid tax charges and to consider the long-term nature of pension savings.

4. Salary Sacrifice: Enhancing Tax Efficiency

Salary sacrifice involves agreeing to exchange part of your gross salary for non-cash benefits, such as increased pension contributions. This arrangement reduces your taxable income and, consequently, your Income Tax and National Insurance liabilities. It’s a government-backed scheme that can result in higher take-home pay and increased pension savings. However, it’s important to assess the impact on other benefits and borrowing capacity, as a reduced salary might affect entitlements and loan applications. 

5. Reimbursing Business Expenses

Ensure that any personal funds used for legitimate business expenses are reimbursed by the company. This practice is tax-efficient, as the reimbursements are not considered taxable income, and the company can deduct these expenses from its taxable profits. Maintain thorough records and receipts to substantiate these expenses. 

6. Share Incentive Plans (SIPs): Employee Ownership

Implementing a Share Incentive Plan allows you to acquire shares in your company in a tax-efficient manner. SIPs offer various options, such as Free Shares, Partnership Shares, and Matching Shares, each with specific tax advantages. Shares held in the plan for over five years are generally free from Income Tax and National Insurance upon withdrawal. This strategy aligns your interests with the company’s performance and can be an effective tool for wealth accumulation. 

Conclusion

A strategic combination of a modest salary, dividends, pension contributions, and other tax-efficient mechanisms can optimize the extraction of profits from your business. It’s imperative to stay informed about current tax rates and allowances, as these can change with each fiscal year. Given the complexities involved, consulting with a qualified accountant or financial advisor is recommended to tailor a remuneration strategy that aligns with your personal financial goals and the specific circumstances of your business.

If you’re facing challenges in your entrepreneurial journey, consider reaching out to professional networks or support organisations for guidance and assistance.

Alex Miller is a professional personal and business coach and mentor, working with start-ups and small businesses in the UK and Europe. Find out more by clicking here Eiger Coaching