Tax-Efficient Ways to Extract Profits from Your Company: Salary, Dividends, Pensions & More
We work with many business owners, and one of the most common questions we’re asked is: “What’s the most tax-efficient way to extract money from my company?”
Inevitably, there’s no one-size-fits-all solution. The best approach depends on your personal circumstances – how much disposable income you need, your longer-term plans, investment risk tolerance, and so on.
That said, there are some well-established strategies that are worth considering. In this blog, we explore a range of tax-efficient ways to extract profits from your business.
1. Salary vs Dividends
The default starting point for most owner-directors is a blend of salary and dividends. This may also include sharing income with a spouse or partner where both are involved in the business.
Here’s how the tax treatment works:
Salary is a deductible business expense – it reduces your company’s taxable profit and therefore its Corporation Tax bill. However, it may be subject to Income Tax, as well as employee’s and employer’s National Insurance Contributions (NICs).
Dividends are paid from post-tax profits – i.e. after Corporation Tax – and are taxed at dividend rates: 8.75% (basic rate), 33.75% (higher rate), and 39.35% (additional rate). These are lower than standard income tax rates - 20%, 40% and 45% respectively.
The traditional approach was to pay a salary up to the Personal Allowance (£12,570 for most people), which attracted minimal National Insurance and secured State Pension credit. Dividends would then be drawn above this level.
However, the landscape has changed in recent years:
The dividend allowance has been reduced to just £500 per year (it was £5,000 a few years ago).
National Insurance rates have been cut (currently 8% for employees), but employer thresholds are tighter.
There’s a more generous Employment Allowance, potentially reducing an employer’s total NICs by up to £10,500 per year – if you qualify.
In short, there are more moving parts than ever. Getting the optimal blend of salary and dividends can deliver significant tax savings – but it needs careful modelling.
We strongly recommend discussing the best approach with your accountant, especially if your circumstances or income patterns change.
⚠️ Please note, the FCA does not regulate tax advice.
2. Employer Pension Contributions
Where you don’t need to draw all of your profits right away, pension contributions made by the company on your behalf can be one of the most tax-efficient ways to extract value, due to the following:
Corporation Tax relief: Employer contributions are treated as a deductible business expense, reducing taxable profits – potentially saving up to 25% in Corporation Tax.
No National Insurance: These contributions aren’t subject to employer or employee National Insurance.
Tax-free growth: Investments within your pension grow free of income tax and capital gains tax.
Tax-free access: You can normally withdraw 25% of your pension tax-free in retirement (currently up to £268,275), with the rest taxed at your marginal rate.
⚠️ Please note, pension funds are usually inaccessible until age 55 (rising to 57 from April 2028). As with any investment, capital is at risk – values can go down as well as up, which may impact the level of benefits at retirement.
How much can be paid in?
There are two key limits to bear in mind:
Annual Allowance: This is currently £60,000* per person per tax year, with the option to carry forward unused allowances from the previous three years (if you were a member of a pension scheme during those years).
‘Wholly and Exclusively’ Rule: HMRC expects contributions to be proportionate to the role of the individual. For company directors, this is usually straightforward. However, one should avoid making large contributions for a spouse or partner who isn’t actively involved in the business, as this could be challenged.
*If your adjusted income (broadly, total taxable income plus employer pension contributions) exceeds £260,000, your annual allowance is gradually tapered down to a minimum of £10,000 once adjusted income exceeds £360,000.
Example: Charlie & Claire
Charlie and Claire, a husband-and-wife team, run a successful business turning over £1m with profits of £400,000. They each draw a salary of £12,570 and £87,500 in dividends – enough to live on with a reasonable surplus left over. They now want to extract some of the residual profits in a tax-efficient way.
They haven’t contributed to pensions for years but each has existing schemes from previous employment – meaning they qualify for carry forward.
Each of them now has:
£60,000 annual allowance for the current tax year
£160,000 of carry forward from the past three years
Total: £220,000 per person
Rather than contributing the full £220,000 at once, they each decide to pay in £100,000 this year – using the current year’s allowance (this must be used first) and the oldest carry forward (from 2022/23, which would otherwise be lost after this tax year).
The result is a combined £200,000 employer pension contribution, saving up to £50,000 in Corporation Tax (25%), with no income tax or NICs due.
They plan to repeat the process in future years to fully utilise their remaining carry forward allowance.
3. Tax Deferral Through Reinvestment
Another approach is to defer profit extraction until a later date – particularly if you anticipate paying tax at a lower rate in the future.
Rather than drawing the profits now, you could leave them within the company. While this means Corporation Tax is still payable on the profits, it postpones any personal tax (income tax or NICs) that would otherwise apply to salary or dividend withdrawals.
In terms of what to do with the retained profits:
Holding them in cash is one option, but business savings accounts often offer poor interest rates – meaning inflation can quickly erode the real value.
Reinvesting in a diversified equity/bond portfolio can be a smarter alternative. This works much like a personal investment account, but held within the company.
Tax Treatment of Company-Held Investments
Here’s how the taxation works on company-held investments:
Capital gains on the sale of investments are subject to Corporation Tax.
Whereas dividends received are typically exempt from Corporation Tax – making them an efficient source of growth or future income.
A popular strategy is to accumulate surplus profits in a company investment account over time. These can then be drawn down gradually in the future – for example, via dividends up to the basic rate tax band – particularly once trading activity has ceased or the directors are no longer earning elsewhere.
⚠️ As ever, we recommend seeking advice from your accountant to ensure any strategy is implemented in line with current legislation and your broader financial goals.
4. Reinvest Surplus Dividends via VCTs
⚠️Please note: Venture Capital Trusts (VCTs) are high-risk, specialist investments. They’re typically only suitable for experienced and high net worth investors.
If you’re in the position of drawing dividends well above your day-to-day spending needs, one left-field strategy is to reinvest some of those surplus dividends into VCTs.
This strategy works as follows
When you take ‘extra’ dividends, you pay income tax – likely at 33.75% (higher rate) or 39.35% (additional rate), depending on your total income.
You could simply accept the tax hit. But if you don’t need the cash right away, an alternative would be to reinvest some/all of those dividends into a portfolio of VCTs – and benefit from 30% upfront income tax relief.
In effect, this allows you to recover a chunk of the tax you’ve just paid.
Worked Example
You extract £20,000 in dividends during the tax year
This results in a £6,750 income tax liability (at the 33.75% dividend rate)
You reinvest the full £20,000 into a Venture Capital Trust
This qualifies for 30% income tax relief – worth £6,000
Net result: You’ve effectively recovered the majority of the tax due on the dividends. While not a complete offset, it’s a powerful way to reduce your overall tax bill – provided the investment is held for the full five years and suits your risk profile.
Note here, EIS and SEIS investments work in a similar manner, offering upfront tax relief (at 30% and 50% respectively). However, these are even higher up the risk curve than VCTs.
Risks
However, there are some important caveats on this strategy:
VCTs invest in small, early-stage UK companies, which come with a high failure rate and significant volatility. These aren’t mainstream investments.
You must hold VCT shares for at least 5 years to retain the initial income tax relief – early encashment triggers a clawback.
Liquidity is limited – you can’t just sell them like a typical fund or share.
Fees are high, often 2–3% upfront, with ongoing charges on top. And most share buybacks are at a discount (typically 5-10%) to net asset value (NAV), reducing your exit value.
Tax rules and qualifying criteria can change, so it’s important to review each offer carefully.
Again, this is not for everyone. But for those with surplus income and the right risk appetite, VCTs can play a useful role in a broader tax planning strategy.
As always, professional advice is key – not all VCTs are created equal, and your accountant will need to factor in any claims via your Self Assessment return.
Conclusion
There are various ways to extract profits from your company in a tax efficient manner. The optimal strategy will depend on your income needs, future plans, and attitude to risk – not to mention the ever-changing tax landscape.
Whichever route you’re considering, the key is joined-up planning – aligning company strategy with your personal goals and ensuring you’re not leaving money on the table unnecessarily.
If you’d like to discuss how to structure things in your specific case – or review your broader financial plan – I’d be happy to help.
Happy Thursday!
Kind regards,
George
Important Disclaimer
This blog is for general information only and is intended for retail clients. It does not constitute financial or tax advice, nor is it an offer to buy or sell any specific investment. Since I don’t know your personal financial situation, you should not rely on this content as tailored advice. While we aim to provide accurate and up-to-date information, we cannot guarantee that all details remain correct over time. We are not responsible for any losses resulting from actions taken based on this blog’s content.
