Is there any investment product that will generate a decent return without relying on dividends?
10 March 2021
Question by Guy
Hello I am a contractor with my own limited company, which means that I generate most of my income through dividends. I put my savings into a stocks and shares ISA but I still have some extra money to invest outside of the ISA allowance. However, any dividend payment will be taxed at 32.5%. Is there any investment product that will generate a decent return without relying on dividends? Thank you!
Answered by Daniel Wiltshire
There are lots of tax planning opportunities for contractors using limited companies; one of the most effective is by using your pension. Pensions are (understandably) more commonly associated with retirement saving but can offer huge tax breaks, particularly for contractors/business owners.
Company contributions to a pension are gross of income/dividend tax, and so rather than paying 32.5% when you draw money from the business, you will instead receive the full amount in your pension.
Pension contributions can also reduce your company’s tax bill. Pension contributions from pre-taxed company income are an allowable business expense and so don’t attract Corporation Tax. This means that a £123.45 pension contribution only costs your business £100 because of the 19% reduction in Corporation Tax.
So for comparison – as a higher rate taxpayer – you would receive £123.45 in your pension compared to £67.50 were you to draw the same amount in dividends.
The catch is that you are unable to access your pension until you are 55 (rising to 57 in 2028), at which point you’ll receive 25% of the accumulated pension pot tax-free, with the rest taxed as income (however at this point you may find that you can afford to draw a lower amount each year – if for example your mortgage has been paid off).
Like dividends, pension contributions are also exempt from National Insurance tax.
Under HMRC rules, company/employer pension contributions must be made ‘wholly and exclusively for the purposes of the business’ to receive relief from Corporation Tax – so it’s worth checking with your accountant or financial adviser if they believe this criterion has been met.
For the 2021/22 tax year, the pension tax relief limit is 100% of your salary with a cap of £40,000. So, if you earn £20,000 in dividends but only £10,000 in salary, the maximum amount you can pay into your pension and still get tax relief is £10,000. But as a business owner one way of ensuring you can make full use of your £40,000 Annual Allowance is to make pension contributions from your company (as an ‘employer contribution’). Although employer and personal pension contributions both count towards your Annual Allowance, employer contributions are not limited by salary.
I hope this helps. I’m afraid I can’t be more specific without a better understanding of your personal circumstances and objectives. Based on the information you’ve provided; I think it would definitely worth speaking to a financial planner to help you understand how best to make withdrawals from your limited company.
Independent Financial Adviser
I’ve worked in finance for 15 years, initially training and qualifying as an actuary before becoming a financial adviser. I set up my own independent practice, Wiltshire Wealth shortly after moving from London to Bradford on Avon with my young family in 2017.