Why Directors Have Unique Financial Planning Requirements

//Why Directors Have Unique Financial Planning Requirements
Guest article by Phil Jenkins, Chartered Financial Adviser, Wren Sterling

Company directors have more options than employees when it comes to financial planning because they can utilise their business to create a remuneration strategy. However, as Phil Jenkins (a Chartered Financial Planner at Wren Sterling) explains, with opportunity comes complexity.

The financial planning landscape for company directors has changed recently, and like anything in financial planning, is subject to constant scrutiny to ensure loopholes are not being created and exploited.

Traditionally, company directors could choose from three options if their business had generated cash: keep profit in the company, use cash for expansion, or pay it out to themselves. Usually, paying money out would take the form of a combination of salary and dividends, with the typical strategy of a low salary / high dividends due to the way that dividends have previously been taxed. The Dividend Allowance introduced in April 2016 has also become less beneficial due to a recent reduction to just £2,000 a year (from 6 April 2018).

Despite changes such as the introduction of the Dividend Allowance and its subsequent reduction, being a company director rather than a salaried employee still has distinct advantages in some of the key areas of financial planning. This article looks at typical financial planning topics and the key differences.

Retirement planning

An increasingly popular strategy for directors is to reduce liability for profits through company pension contributions. This equates to a 19 per cent Corporation Tax saving, plus the additional benefit of saving personal tax and National Insurance (NI) contributions (in comparison to withdrawing the profits as either salary or dividends). Company contributions to pensions are theoretically unlimited, but an individual’s Annual Allowance (AA) of £40,000 a year is still in place and will act as a cap to contributions in the prevailing tax year.

Importantly, in most cases, this strategy will not be dependant on the salary level of the company director, so it is compatible with the common remuneration approach of lower salaries / higher dividends.

High dividend income example

Mr Patel, aged 60, has total remuneration of £100,000. This consists of £8,424 salary and £91,576 dividends. He will also be able to make use of his Personal Allowance (the amount of income you can earn before paying tax. This is £11,850 for Mr Patel for the tax year 2018/19).

His salary attracts no Income Tax and leaves £3,426 of the Personal Allowance, which is covered by some of the dividends.

The remaining dividends will be taxed as follows:

£2,000 @ 0%

£33,500 @ 7.5% = £2,512.50

£52,650 @ 32.5% = £17,111.25

His total tax bill = £19,623.75

Alternatively:

If Mr Patel takes £8,424 salary and £16,576 dividends and his company makes £75,000 employer pension contribution, his salary and the first £3,426 of dividends remain within the Personal Allowance. The remainder is taxed as follows:

£2,000 @ 0%

£11,150 @ 7.5% = £836.25

This results in £18,787.50 less tax, plus a Corporation Tax relief of 19% on the employer contribution of £14,250.

As Mr Patel is over 55, he can also benefit from the availability of his ‘tax-free cash’ and can take 25% of the £75,000 pension contribution (£18,750).

The remainder of the pension is taxed at marginal Income Tax rate (assume basic), which is £56,250 @ 20% (£11,250).

His Annual and Lifetime Allowance limits should also be considered, as well as the fact that the pension sits outside of the individual’s estate for Inheritance Tax (IHT) purposes.

Salary Dividends Employer Contribution Income Tax Saving Corporation Tax Saving
Scenario 1 £8,242 £91,576 £0
Scenario 2 £8,242 £16,576 £75,000 £18,787.50 £14,250


Pension taxation assumes no growth and no associated costs for the purposes of this illustration.

Protection

Company directors can use their business to make sure they’re protected and save money by making the business the owner of their protection policies.

A Relevant Life Policy is essentially a life insurance policy written by the business and offers potential tax benefits. Premiums are paid by the company and may be treated as a business expense (subject to agreement with HM Revenue & Customs), and the cover does not contribute to an individual’s Lifetime Allowance.

Executive Income Protection will provide a replacement of income in the event of the director being unable to work due to sickness or accident. This is similar to a standard Income Protection policy, except the business is the policy owner in this case. In general, the business may be able to offset the premiums against tax as an allowable expense, but this depends on the nature of the business, so make sure you speak to your financial adviser.

Succession planning

In much the same way as an individual would look to pass wealth on to loved ones, a company director (who may have a large proportion of their wealth tied up in a business) will typically look to pass on wealth in a tax-efficient manner.

Shareholder Protection can ensure a smooth conclusion to any business succession problems, minimise the impact to the business of the loss of a key shareholder, and provide the shareholder or their family with the true worth of their shares.

A Business Will is another consideration for directors. For certain businesses, the business must cease trading on death. This could have a catastrophic effect on the value of the business, meaning that the beneficiary or beneficiaries may receive little or no inheritance.

Providing that Business Property Relief is permitted (the company must be a trading company / not an investment company), then potentially there will be no IHT payable by the beneficiaries when inheriting the company.

This is just a brief summary of the succession planning options open to company directors, but this is a complex area and requires advice from your financial adviser and often a solicitor as well.

Exiting the business

Planning can be undertaken to either sell or wind up the company and can mean that the directors qualify for Entrepreneurs’ Relief (ER), providing it is granted. In this case, capital gains tax (CGT) is attached to the disposal/value of the business’ assets at a rate of ten per cent up to an amount of £10 million.

Contractors

HMRC documents

Historically, contractors may have wound up their business and restarted a new one on a regular basis, and benefiting from reduced rates of tax. HMRC has tightened the rules on this practice, and guidance now says that directors are ineligible for ER if the purpose of the wind up was to target tax advantages. Issues may arise if contracting is restarted within two years, and HMRC may challenge the original distributions under the anti-avoidance rules. There’s also a risk if directors try to get around the guidance that HMRC could investigate previous activity.

HMRC documents

The risk of holding too much cash
If a business holds too much cash, it is prudent for directors to look at how the company is structured to avoid potentially losing a value benefit such as Business Property Relief, which could mean successors could pay CGT on inheritance. For example, if you’re a grocer turning over £200,000 a year, yet you’ve built up cash reserves of £800,000 over many years of trading, HMRC could deem you to be an investment company as your main business activity.

This is one area where it pays to talk to an expert – as an adverse outcome in this situation can critically impact tax treatment in several areas.

Profit extraction

In many ways, the content of this article is responsible for this next issue! Directors can sometimes hoard cash for fear of falling foul of taxation because they don’t understand the complexities of the tax regime, yet this can result in another risk. If a company holds lots of cash in a current account instead of investing it, it is effectively losing value, so it is prudent to look at corporate investment options.

Next steps

Businesses are moving all the time, so as well as a one-off review, it’s important to have regular reviews with your financial adviser.

The value of the business, policy excess, dividends legislation, the Lifetime and Annual Allowance, changes to company directors, inheritance, and succession plans can all change at a moment’s notice and have a knock-on effect on the best-made plans.

If you’re a company director and have never considered your business as a financial planning tool, or it’s been several years since you revisited your plans, please get in touch with your adviser to arrange an appointment. If you don’t have a Wren Sterling adviser, please contact marketing@wrensterling.com

Important: The levels, bases, and relief from taxation are subject to individual circumstances and may be subject to future change.

2018-06-28T15:26:50+00:00 June 28th, 2018|Finance|Comments Off on Why Directors Have Unique Financial Planning Requirements