Profit extraction: salary, dividend or pension
Priya is the sole director and 100% shareholder of P Ltd, a trading company with profits before director's remuneration of £95,000. She has no other income and needs £40,000 of cash personally in 2024/25 for a house deposit. She also wants to build retirement savings and has asked whether a company pension contribution is better than a bonus. P Ltd has no other employees, and Priya currently pays herself a salary of £12,570. She is considering increasing her salary to £50,270, taking a £40,000 dividend, or making a £30,000 employer pension contribution. Her accountant has warned that P Ltd may exceed the £50,000 small profits threshold if profits rise next year.
1. Compare the tax outcome of extracting £40,000 as an additional salary/bonus versus a dividend, assuming P Ltd has sufficient retained profits. Show the key calculations and state which is better for Priya.
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Assume 2024/25 rates: employer NIC 13.8% above £9,100; employee NIC 8% between £12,570 and £50,270 and 2% above; dividend allowance £500; CT 19% on profits below £50,000.
Bonus of £40,000
- Employer NIC: £40,000 × 13.8% = £5,520. Total deductible cost £45,520.
- CT relief at 19% = £8,649, so net cost to the company is £36,871.
- Income tax: taxable pay £40,000 = £37,700 × 20% + £2,300 × 40% = £8,460.
- Employee NIC: £37,700 × 8% = £3,016, plus £2,300 × 2% = £46; total £3,062.
- Net to Priya: £40,000 − £8,460 − £3,062 = £28,478.
Dividend of £40,000
- The company must earn £40,000 / 0.81 = £49,383 to pay it after 19% CT. CT = £9,383.
- Dividend tax: £500 allowance; £37,200 × 8.75% = £3,255; £2,300 × 33.75% = £776; total £4,031.
- Net to Priya: £40,000 − £4,031 = £35,969.
For the same £49,383 of pre-tax profit, a bonus would be about £43,395, yielding roughly £30,447 net after IT/NIC. The dividend is better by about £5,500. Caveat: if P Ltd's profits fall in the marginal relief band, the effective CT rate rises towards 26.5%, narrowing the gap. Salary up to the personal allowance is still preferable to dividend because it is deductible and NIC-free.
2. Would a £30,000 employer pension contribution be better than either option for Priya?
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An employer pension contribution is deductible for CT and is not taxable income or a NICable benefit for Priya. The company gets relief on the full £30,000, saving up to £5,700 CT at 19%, so the net cost is about £24,300 of post-tax profit. To put £30,000 into a pension via dividend, the company would need to earn about £37,037 and Priya would pay dividend tax on the extraction.
The trade-off is access: pension funds are locked until age 55 (57 from 2028). Because Priya needs £40,000 cash for a deposit, the pension cannot replace the salary/dividend extraction; it should be used for the surplus profit after her cash need is met. Check the £60,000 annual allowance and any carry-forward.
3. Priya's profits are expected to rise to £120,000 next year. How does that change the analysis?
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At £120,000, P Ltd is in the marginal relief band (£50,000–£250,000), so the marginal CT rate is 26.5%, not 19%. That makes dividends less attractive: the company must earn more pre-tax profit for each £1 of dividend, and the dividend tax rates remain 8.75%/33.75%.
A larger salary may become relatively more attractive because it is deductible at 26.5% and avoids employer NIC only below the secondary threshold. But watch the £100,000 personal allowance taper: between £100,000 and £125,140 the effective marginal income tax rate is 60%, which would make a salary increase in that range very expensive. The best answer is likely a salary to £50,270 or lower, dividends for the balance, and a pension contribution to reduce profits out of the 26.5% band.