Many business owners will face the tough question of managing the money they have been earning through the company. Perhaps the worst decision is to leave it idle in a business account with low or no income paid but this is likely a common occurrence.
This money can be earmarked for various things, whether it be dividends, for reinvestment in a business or as rainy-day emergencies. But it can also be merely idle.
Below, Trustnet asked Lena Patel, independent financial advisor (IFA) and director of ISJ Financial Planning, when someone should consider moving the money and how they can do so tax efficiently.
To do this, we have used the example of an NHS doctor with a private practice, who has money sat idle in an account. However, the advice can apply to a range of people, including small business owners and single-person companies, such as freelancers and consultants.
When to withdraw and when not
Patel highlighted three main reasons why someone might want to withdraw funds from a corporate account, depending on their financial goals.
For example, mortgage holders might want to consider overpaying their debt, which is a particularly sensible solution if the mortgage rate is higher than the return on investments.
“In this case, it might make sense to use business funds to reduce debt,” she said. “However, mortgage overpayment could limit liquidity if you need funds in the short term.”
This has an opportunity cost: if the funds are invested within the business and are generating good returns, it may be better to leave them invested rather than withdrawing them and potentially losing out on that growth.
Another cause worth pursuing could be maximising a personal ISA. Each financial year, every UK citizen has a tax-free ISA allowance of £20,000. If that hasn’t been used up it may make sense to withdraw money from a private practice and contribute to a Stocks and Shares ISA to take advantage of the tax-free growth, the IFA said.
The last reason could be for extra income. “If you need additional income to cover personal expenses, withdrawing funds as salary or dividends may be necessary, especially if your business cash flow allows for it without jeopardising its operations,” she said.
“If your business is in a growth phase or experiencing cashflow challenges, keeping funds in the business is essential for ongoing operations.”
Things to consider also include tax penalties: if taking money out would trigger significant tax liabilities or affect one’s ability to reinvest in the business, it might be better to leave the funds where they are, according to the adviser.
So let’s now take a look at the four main ways to reclaim the funds and the potential price tags.
How to withdraw and tax implications
There are four primary options to free up the money, each with different tax implications. First is salary, one of the more expensive routes.
“If you’re a director or employee of your business, you can pay yourself a salary,” Patel explained. “This is subject to income tax and National Insurance contributions, but you may also be eligible for tax relief on pension contributions from your salary.”
If the business is a limited company with share participation, money can be paid out in the form of dividends, which are paid from profits after tax.
The first £1,000 of dividends is tax-free under the dividend allowance, but anything over that is taxed at different rates depending on total income. The rates are generally lower than income tax rates on a salary, making this a more tax-efficient way of cashing in.
Those who only temporarily need a part of the money could look into taking a loan from the business. This must be repaid, and if the loan balance is not cleared within nine months of the company's year-end, there could be tax implications, such as additional charges if the loan balance exceeds £10,000 at any point during the tax year.
Finally, sole traders or partners in the business can simply draw money from the account for personal use, with no tax bills to pay at the time of withdrawal. The amount doesn’t affect the taxman’s share directly, but there are levies due on the overall profits of the business, Patel explained.
In all cases, it's important to consider the short-term and long-term financial health of the business, as well as the personal tax situation. It is wise to seek financial advice to make sure decisions are made tax-efficiently and based on personal circumstances.