Profit Extraction

In my experience, one of the key challenges facing any business owner is how you convert your enterprise into wealth, or, to put it another way, how you can extract the rewards for the many years of hard work and personal sacrifices that have been made in building your business to create financial independence for yourself and your family.

It can take many years to build a successful business and it’s important to ensure that you protect your profits from excessive taxation. Trying to withdraw profits from your business can be particularly challenging once you become a higher rate tax payer. However, as a business owner, it is crucial to ensure that you are regularly taking profits out of your business in a sustainable way that helps create a tax-efficient source of independent income when you retire. This is therefore a key element of Business Continuity Planning.

One of the most effective ways to create a profit extraction strategy is to use pensions.

There is an immediate benefit of paying profits into a pension because the payment is a deductible expense against Corporation Tax. For example, if you contribute £10,000 to a pension, you will receive a £1,900 reduction in your Corporation Tax bill for that tax year.

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Furthermore, pension contributions do not attract any Income Tax, National Insurance or Dividend Tax. This means that what you pay in is what ends up in your pension. Pensions also have the additional benefit of being exempt from Inheritance Tax. The maximum you can pay into your pension each tax year is £40,000; however, larger contributions may be available in certain circumstances.

When you reach retirement, you can start to withdraw money from your pension and, provided you’ve put the right planning in place, they should ensure a comfortable and secure retirement. A well-funded pension helps provide financial independence, which means that the timing of your retirement is not solely dependent on the sale or exit strategy of your business.

Allowing profits to accrue in a business bank account can have serious implications for Inheritance Tax and Entrepreneurs’ Relief. It is vital that you engage with your accountant and financial adviser to ensure that your retained profits and pension contributions are at an appropriate level for your business plans. Here at Wellesley Wealth Advisory, we can help.

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