If you are running a profitable business it is likely that you have quite a lot of cash in the business and often you will be advised that if you take too much dividends or a high salary you will get taxed. This causes you to have cash in your business that you do not know what to do with. There are different strategies to take into consideration in order to enable you to use that cash in your business.
Aidan Dow, the company director of Aidan Dow Wealth Management Ltd, has taken some time to sit with Hannah Xu to talk about the different strategies and the steps you can take.
What to Do If You Want to Keep Some Cash in The Business?
If you have a company there is nothing to stop your company from having investments which means you can open investment accounts on behalf of your company. This enables you to put some funds in these investments, it is key to know how long you think you can tie the money up. If you are looking at using that money before 3-5 years it is recommended not to have an investment account or taking stock market risks. It is a good strategy to have an investment account for the business which is also separate from your name and taxed separately to your own name.
It is important to know what your objective is and how much cash you will need for the short-term but if you do not need it then an investment account is a good option for you. With interest rates so low, if you are keeping cash in the business, effectively over 2-3 years that money is going backwards. Whereas, if you can afford to tie up for 3-5 years and take some investment risk then that money will keep pace with inflation which will keep your business healthy. The money is there to call on when you have needs and you can take it out in a more tax efficient way.
What Are the Risks?
Because you are in control of the company’s money, you can control how much risk you take with the investments. You are not restricted within the company regulations to be fixed to a low-risk or high-risk. You are able to pick your risk which means you have the flexibility of having it towards the low risk side which is down towards cash or bring in some risk in with some equity exposure.
Company Pension Contribution
A company can make pension contributions to an individual, this means that the individual will get better remuneration even though you cannot access it until you reach retirement age. It is tax efficient for the company because the company does not pay National Insurance on the pension contribution. If you are paying yourself more or the company is paying individuals more then the company would have to pay National Insurance on the salary payments it makes. If the company pays into a pension on behalf of the individuals, in some ways it feels like a salary because it is a benefit but the company does not pay National Insurance on that contribution.
Pension contribution is one of the tax deductions for your company tax. An example of this is if you have kids there is employer supported childcare which you can take advantage of.
Advice on Having Cash in The Company
- Know how much cash the company needs for running costs for 3-4 years before you consider tying up any cash in investments.
- Understand the risk, understanding your own risk profile and how the company risk profile may be different from your own risk profile because they are two different entities. Saving for the 20-30 years will have a different risk profile of saving for 4-5 years and it alters the investment profile quite dramatically by having two different time scales.
Venture Capital Trusts
Venture Capital Trusts have been running for about 20 years and it is a government scheme used to encourage investments in smaller companies and start-up companies. The government is offering really good tax breaks for people taking risks and investing in these companies. Most people start to consider this option once they have used up their ISA allowance and their pension contributions. Any money you put into a Venture Capital Trust you get tax relief on. If you invest £1, you get 30% tax relief on that £1. Throughout the life of that VCT you will get a dividend payment and it will be tax-free.
VCT are made up of a collection of up to 20 or 30 individual venture type companies, they offer growth opportunities and offer diversity because you cannot access this area of the market through normal stock markets. They are high-risk investments so it is best not to invest in them purely for the tax relief. Once you put money in, you cannot access the capital for 6 years. You cannot change the risk profile within the 6 years which is unlike a pension.
Are VCT’s and Pension Contributions Good Options for People Who Are Not Risk-Takers?
The default rate of VCT’s failing is quite high and it is up around 40%. It is a fund of different venture companies which means there is a fund manager sitting over that and picking the best investments for their Venture Capital Trust. What they usually do is meet 1000 different companies and each year they will only invest in 6. By narrowing it down it helps to reduce some of the risk. They will also pay out to these venture companies capital, so over the period of 6 years they will give a small amount in year 1 then more in year 2 etc. What eventually happens is that the companies that are not doing so well do not get much of the money because they tend to fail within 2 or 3 years. The companies that do well will receive more money and the default rate drops from 40% to 14%.
Pension Contributions are very tax efficient. Once you put money into your pension you can play around with the risk level you are taking within that pension which is positive as you are not locked into high-risk. Although you do not have access to the money, you have access to the risk within the pension.
What is Tax Relief?
If you earn anything over £11,000, you will pay 20% tax on that and if you earn over £45,000 you will pay 40% tax. If you are in that bracket and you are earning over £11,000, anything you contribute into a pension the government will give the equivalent of the amount of tax back. If you invest £1 you will get £1.40 invested which is worth it.
P.S. If you find this content useful, we do provide tailored professional advice on your personal or business tax matters. If you are interested, please book me in via the link so we can arrange a chat: https://hannah-xu.youcanbook.me