If you run a limited company, you’ll likely want to take money out of it at some point – whether that’s to pay yourself, fund personal expenses, or simply enjoy the fruits of your hard work. However, the way you extract profits from your company can have a significant impact on how much tax you end up paying. Understanding your options can help you keep more of what you’ve earned.
What does ‘extracting company profits’ actually mean?
When we talk about extracting profits, we’re referring to the various ways you can legally take money out of your limited company for personal use. Your company is a separate legal entity, so you can’t simply help yourself to the cash in the business bank account – there are specific methods you need to follow, each with different tax implications.
The key is finding the most tax-efficient combination of these methods that works for your personal circumstances and business needs.
The main ways to extract profits
There are several legitimate routes for taking money out of your company, each with different tax treatments:
Salary
This is probably the most straightforward approach. You pay yourself a salary just like any other employee, with income tax and National Insurance deducted through PAYE subject to allowances. The company also pays employer’s National Insurance contributions on top where due.
Dividends
These are distributions of company profits to shareholders. Dividends are paid from profits that have already been subject to corporation tax, and they’re taxed differently to salary – there’s no National Insurance to pay, but dividend tax rates apply instead.
Pension contributions
The company can make contributions directly to eligible pension schemes. These are usually tax-deductible for the company and don’t create an immediate personal tax charge for you.
Benefits in kind
These include things like company cars, private medical insurance, or other perks. The tax treatment varies depending on the specific benefit.
Loans
In certain circumstances, you might take a loan from your company, though this area has strict rules and potential tax implications that need careful consideration.
The salary and dividend combination – why it’s often optimal
Many small business owners find that a combination of salary and dividends provides the most tax-efficient approach. Here’s why this strategy often works well depending on other personal circumstances:
The optimal salary level
For the 2025/26 tax year, many business owners pay themselves a salary around the National Insurance threshold (£12,570). This level allows you to maintain your National Insurance record for state pension purposes without creating significant tax charges for you or the company.
Why dividends can be tax-efficient
Dividends don’t attract National Insurance contributions, which can make them more tax-efficient than salary for extracting larger amounts. However, they can only be paid from available profits after corporation tax has been paid.
The dividend allowance
There’s currently a dividend allowance of £500 per year (reduced from £1,000 in previous years), meaning the first £500 of dividends you receive are tax-free. Beyond this, dividend tax rates apply: 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers.
Practical considerations for your extraction strategy
The best approach for your business will depend on several factors that are worth thinking through:
Your total income needs
If you need to extract significant amounts annually, you’ll likely want to use a combination of methods. The optimal balance will depend on your personal tax position and the company’s profit levels.
Timing of extractions
You might want to consider the timing of dividend payments. For example, if you expect your income to be lower in a particular tax year, it might make sense to take larger dividends then to stay within lower tax bands.
Company profit levels
Dividends can only be paid from available profits. If your company hasn’t made sufficient profits, you won’t be able to pay dividends regardless of how tax-efficient they might be.
Future business needs
Consider whether the company needs to retain cash for future investment, expansion, or working capital requirements before extracting profits.
Pension planning
Company pension contributions can be particularly tax-efficient, especially if you’re a higher rate taxpayer. The company gets corporation tax relief, and you don’t pay immediate personal tax on the contribution.
Understanding the tax implications
The tax treatment of different extraction methods can be complex, but understanding the basics helps you make informed decisions:
Corporation tax
Your company pays corporation tax on its profits before dividends can be distributed. The current rate is 25% for companies with profits over £250,000, with a lower rate of 19% for smaller companies (though this is subject to marginal relief calculations).
Personal tax on salary
Salary is subject to income tax at 20%, 40%, or 45% depending on your total income, plus National Insurance contributions at 8% (reducing to 2% on earnings above £50,270).
Personal tax on dividends
Dividend tax rates are 8.75%, 33.75%, and 39.35% for basic, higher, and additional rate taxpayers respectively, after the £500 dividend allowance.
The interaction between corporation tax and dividend tax
It’s worth noting that when you account for both corporation tax paid by the company and dividend tax paid personally, the total tax burden on extracted profits is generally higher than the headline dividend tax rates might suggest.
Common mistakes to avoid
Several pitfalls can reduce the tax efficiency of your profit extraction or create compliance issues:
- Paying dividends without sufficient profits
This creates illegal dividends, which can have serious consequences. Always ensure your company has sufficient distributable reserves before declaring dividends.
- Ignoring National Insurance record implications
Paying yourself too low a salary might save tax in the short term but could affect your state pension entitlement or other statutory benefits.
- Overlooking timing opportunities
Tax rates and allowances change, and your personal circumstances may vary from year to year. Regular reviews can identify opportunities to optimise your extraction strategy.
When to seek professional advice
While the basic principles are straightforward, the optimal extraction strategy for your specific situation can be complex. Professional advice becomes particularly valuable when:
- Your company is generating substantial profits
- You have other sources of income that affect your tax position
- You’re considering significant one-off extractions
- Your business circumstances are changing
- You want to incorporate longer-term tax planning
Planning for the future
Tax rules and rates change regularly, so what works optimally today might not be the best approach next year. The key is to establish a flexible strategy that can adapt to changing circumstances while ensuring you remain compliant with current requirements.
Consider reviewing your extraction strategy annually, particularly around the time of budget announcements when tax changes are typically announced. This allows you to adjust your approach for the coming tax year if beneficial.
Getting the balance right
Tax-efficient profit extraction isn’t just about minimising tax – it’s about finding the right balance between tax efficiency, business needs, personal requirements, and compliance obligations. The most successful approach is usually one that considers all these factors together rather than focusing solely on tax savings.
At Smethurst & Co, we help business owners navigate these decisions every day. We can review your specific circumstances, model different extraction strategies, and help you implement an approach that works for both your business and personal situation.
Ready to optimise your profit extraction strategy?
If you’d like to explore tax-efficient profit extraction for your business, Smethurst & Co is here to help. We can assess your current approach, identify opportunities for improvement, and support you in implementing a strategy tailored to your specific needs.
You can reach us on 01472 357125 or email advice@smethurstandco.com to arrange a profit extraction consultation.
