Why put the money away for the future if you are happy paying the dividend tax?
Some business owners would rather take the money out and have this in their current account so that they have total control on this – presumably they believe they don’t control their pensions?
But if they saw the following example of how this would work for 2017/18, would they still have the same opinion?
Isla has a business and is taking profits from this in the form of dividends, she is a higher rate tax payer and is taking £1,000 net more than she needs each month to put in her bank account (this is over and above the zero rate of taxation on dividends). If she put this into a pension, then her situation would be greatly altered.
£1,000 a month equates to £12,000 per annum. Grossing this back up with the higher rate of dividend taxation applied along with the corporation tax that has to be paid before dividends can be paid. So, the total profits from the business needed to provide this dividend becomes £21,948.15.
Paying this from the business to a pension would avoid immediate taxation (corporation tax and dividend tax in this case).
If she extracts this pension as a higher rate taxpayer when she takes benefits and factoring in the 25% tax-free Pension Commencement Lump Sum (PCLS), she will have £15,363.71, a 28% return on the £1,000 a month given up.
The Centre for Policy Studies research has estimated that 6 out of 7 higher rate taxpayers are not higher rate taxpayers in retirement. So, assuming that Isla is a basic rate taxpayer in retirement, this would give her £18,655.93, a whopping 55.47% increase on what has been given up.
If you asked Isla if she is willing to give up £12,000 a year in her current account that she presently doesn’t need and instead have £18,655.93 in her bank account when she is retired, what would she say?
Conclusion
Whilst this can be technically complex is the planning not straightforward? The basis of financial planning is to make clients richer, and if Ltd Company owners are still using the low salary / high dividend methodology that seems almost ingrained now, are they missing a trick?
Based on the above you should extract the minimum amount of profit required to fill your current account for immediate needs (both essential and non-essential) and the rest goes into your pension to maximise your current account of the future. Unless you can invest to make your current account bigger than what your ’future current account’ would be…