Learn about the tax problems of holding too much cash in your company. Successful companies can accumulate significant cash balances if profits are left in the business and not paid out as salaries or dividends. That you may think is a risk-free strategy from a tax perspective and there is nothing wrong by holding cash which has been earned from profits in your company until you approach retirement.
I have seen several clients over the years leave accumulated cash in their company with the intention of taking a large pay out when the company is wound up or sold on their retirement. They are looking to take advantage of Business Asset Disposal Relief where they will pay 10% capital gains tax on the first £1m and 20% on any excess.
This compares well with the tax rates they would incur if they extracted the money as salary or dividends when the tax rates can range from 8.25% to 45%.
There is another alternative to consider – extract some of the profits as employer pension contributions.
The pension contributions are eligible for corporation tax relief (currently at 19% but rising to 25% after 1 April 2023). The business owner does not have to worry about selling or winding up the company and the funds extracted can grow in a tax free environment.
One other consideration to bear in mind is that once you have extracted funds from your company and put them in your pension pot, they are safe should anything go wrong with your company in the years ahead.
If we crunch the numbers the best result between opting to liquidate your company or extracting the cash via the pension route depends on whether, when you come to tax your pension, you are a basic rate taxpayer.
If you can keep your affairs in retirement so that you only pay basic rate then the pension route is advantageous, however if in retirement you are a higher rate tax payer then the liquidation route may work for you.
In this blog I have provided generic advice so you should always speak to your professional advisor before taking action. Individuals with have different preferences depending on many factors such as the sector their company trades in, their attitude to risk, the make up of their family.
I would always advise business owners in these circumstances to plan early rather than leave matters until they are approaching retirement.
If you find yourself in a position similar to that outlined above, please get in touch so that we can start the planning process.
