Business Owners - How to Save Tax, Grow Your Wealth and Reduce Risk

If you're reading this, chances are you're a business owner, who would like to save tax and grow your wealth. Well, if so, you're in luck.

First, the bad news. For many business owners, January brings the self-assessment tax deadline and the challenge of paying a big tax bill. It's often painful, and leaves you wondering if you're missing a trick and could be more tax-efficient.

Two Birds, One Stone

Tax is a big issue for business owners, so you need to know how you can leverage tax-efficient investments, such as Pension and ISAs, to reduce your tax burden, keep more of your money for yourself, and enable it to grow for your long-term benefit.

By being tax-efficient with your income, you'll save tax and benefit from compounding, which takes the strain of saving for your future self. You could say, it's like the old 'two birds, one stone'

If It's Good Enough For Einstein...

Investments in pensions and ISAs are not only tax-efficient, but also benefit from compounding interest (or in this case compounding investment returns), which could be life-changing if given the time.

A quote often attributed to Albert Einstein (although nobody knows if he actually said it or not): "Compound interest is the 8th wonder of the world, those who learn it, earn it. Those who don't, pay it."

Risk of Not Doing It

One day you'll no longer run your business and will instead ride off into the sunset in your convertible, never to return.

You may be hoping for a big capital event, such as a sale, to fund for your retirement, and there's nothing wrong with that. As long as it works out.

Without spreading some of your wealth elsewhere, that's a lot of eggs in one basket, which can go wrong and I've seen happen before.

Instead, why not be more tax-efficient now, benefit from the powerful forces of long-term compounding later, and all the while, diversify your wealth, reducing the reliance on your business to be the motor of your long-term financial security.

This holistic approach to wealth management helps secure your financial future. Here’s how:

1. Understand Your Tax Obligations

First, don't forget that you've got to pay this year's tax!

January’s tax return typically includes:

• The balancing payment for the previous tax year.

• The first payment on account for the current tax year.

  
  

Being clear on what you need to pay, and why, will help you plan better and identify opportunities to reduce liabilities.

Speak to your accountant to better understand how you can reduce your tax liabilities for the year coming up. For example, understanding what are 'allowable expenses' which are things that can legitimately be put through the business, which reduces your corporation tax liability.

2. Pension Contributions: Securing Long-Term Wealth

Why Contribute to a Pension?

Pension contributions are one of the most effective ways to reduce your taxable income while building a safety net outside your business.

They are an allowable expense, meaning for every £1 you put into a pension as an employer contribution is £1 that is taken off your pre-tax profit figure and therefore saves on corporation tax.

Here's a quick example:

Put £1,000 a month into a pension for 20 years, with an assumed investment growth rate of 6% a year.

You'd contribute £240,000 over the 20 years and end up with a pension pot worth £462,041. That's 93% more than you've put in, by saving little and often and letting the investments compound. Most of that growth comes in the later years, as the chart below shows.

Of course a 6% return isn't guaranteed, but it's not an outrageous assumption for a long-term investment return of a pension pot for most people. By taking more risk, you could achieve a higher return and by taking less risk you could get a lower return.

Anyway, by making this level of contributions, you'll also reduce the amount liable to Corporation tax by £12,000 a year, saving yourself £3,000 corporation tax each year, assuming a 25% corporation tax rate. Over 20 years, that's a cool £60,000 corporation tax saved.

If you were to instead take the money out as dividends, you'd be left with £9,000 in the business after paying £3,000 corporation tax and then be able to take £5,963 as dividends, assuming you pay higher rate tax on dividends at 33.75%.

£12,000 in your pension or £5,963 in your pocket?

Compounding Marshmallows & Choice

This is simply a real-life version of the 1970 Stanford Marshmallow experiment (Wikipedia Link), whereby children were given the choice of having one marshmallow now, or the promise of two if they waited longer.

But, if you think about it, you're given two instead of one here (£12,000 being twice as much as £6,000), except that the 'two' could multiply into many more marshmallows (money) in retirement!

Plus, if you instead take that £5,693 now, will you save it and do something useful with it, or will you likely spend it?

Play around with a compound interest calculator like this one, to see how compounding could benefit your pension contributions:

https://www.unbiased.co.uk/discover/personal-finance/savings-investing/compound-interest-calculator

Don't forget as well, that the majority of people remain in Drawdown pensions in retirement, meaning the funds remain invested and still benefit from compounding growth, and not just up to the point of retirement.

Maximise Your Annual Allowance

Here's a little-known rule which you can benefit from as a business owner.

The standard Annual Allowance is £60,000 total contribution to pensions per person per year, and contributions cannot exceed 100% of your total pensionable earnings for the year. This means if your income is £50,000 this year, you cannot put more than £50,000 into your pension, including tax relief.

However, there is no limit on what a business can contribute to an employee's pension as an employer contribution, which therefore removes the link with pensionable earnings. Don't forget, if you're a Ltd co. business owner, you are technically an employee too.

Contributions need to meet HMRC's 'Wholly and exclusively' rules, which essentially mean that an expense made by a business is wholly and exclusively for the purposes of the their trade, as outlined here: https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim37007

Ensuring a business owner can retire and that the business can continue thereafter, should meet the definition of wholly and exclusively in most cases!

Exceeding the Annual Allowance

Whilst you can break the link with pensionable earnings, you can't break the link with the Annual Allowance.

However, you can carry forward up to three years of previous Annual Allowances if any of those allowances are unused, as long as you were a member of a pension scheme in those years.

The Annual Allowance gets complicated if your income is over £200,000 in a year. Then you may end up with a Tapered Annual Allowance, which starts to bring down your Annual Allowance relative to how much over £200,000 your income is. If you're making pension contributions with an income over this level, you really should think about getting financial advice.

Making Large Contributions Near to Retirement

Combining the Carry Forward rules with being able to make large employer pension contributions could be a great way to catch-up on filling your pension if you've left it late before you intend to retire.

Don't forget, when you draw on it, 25% of the pension pot is tax-free, and you can then flexibly draw the remainder as required in retirement to fit in with your tax position and ensure any withdrawals are tax-efficient.

3. ISAs: Tax-Free Growth Beyond Your Business to Save Tax and Grow Wealth as a Business Owner

The Role of ISAs in Diversification

Individual Savings Accounts (ISAs) provide a tax-free environment for investments, making them an ideal vehicle for diversifying wealth.

Contributions? Tax-free ✅

Growth? Tax-free ✅

Withdrawals and Dividends? Tax-free ✅

Maximise Your ISA Allowance

For the 2024/25 tax year, individuals can invest up to £20,000 into ISAs. For couples, this allowance doubles to £40,000 (although accounts can only be held in individual names), providing an excellent opportunity for family wealth growth.

Do this every year for 10 years and you've got £400,000 in ISAs. When you add compound interest principles in exactly the same way as with pensions, you can see the potential for large amounts of capital that will always be tax-free.

By withdrawing profits strategically through salary or dividends, you can fund ISA investments. Yes you'll pay tax now to do it, but having a growing pot that you can draw from tax-free provides very useful capital for you to use personally, and a potential funding source to put back in the business as a director's loan if circumstances required.

Access Before Retirement

Whilst pensions are more immediately tax-efficient, as you get tax relief on contributions, you can't access the money immediately should you need to, unless you're over 55.

With ISAs, you won't get immediate tax relief, but what you get instead is no restrictions on when you can access the money held in them.

If you're a younger business owner, it may be that taking the hit on tax efficiency immediately is worth it to ensure you've got more flexibility with your investments and the money isn't locked up until your mid to late 50's.

Where the Magic Happens - Tax-Efficient ISA & Pension Income in Retirement

This is where things can get really interesting, from a nerdy tax-efficiency point of view that is.

ISAs can work brilliantly in tandem with pensions in retirement due to our income tax system.

Each individual has a £12,570 Personal Allowance in the 2024/25 tax year. This means you can have income up to this amount and pay no tax on it.

Thereafter, income is taxed at 20% up to £50,270.

Let's say you're married and you've worked out you need £50,000 income each year in retirement to enjoy a well-earned comfortable lifestyle.

If you've properly funded your Pensions and ISAs during your working life for you and your spouse, you've got pots that allow you to be fully tax-efficient with your income, like so:

Person 1 income:

• £12,570 - 'taxable'pension income, using up Personal Allowance

• £4,190 tax-free pension income

• £8,240 ISA income

Person 2 income:

• £12,570 - 'taxable'pension income, using up Personal Allowance

• £4,190 tax-free pension income

• £8,240 ISA income

Tax Paid: £0

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How do you each end up with two lots of pension income?

Well, remember that 25% of your pension is tax-free. That doesn't mean you have to take that as a lump sum. You can take a little bit of your total allowance with each income payment.

In the above example, each person withdraws £16,760 from their pension. 25% of £16,760 is £4,190. The taxable 75% part provides the £12,570, but this is within your Personal Allowance, so is free of tax.

Fund your pensions and ISAs properly, and you can take over £4,000 a month between you, without paying a penny of tax.

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There are actually three neat functions of this approach:

1) Using two individual's income tax allowances instead of one.

2) Using tax-free cash for income - most people don't realise you can do this.

3) Using regular ISA withdrawals for more tax-free income. Again, most people don't know you can set up regular withdrawals from ISA portfolios.

If instead one person tried to use a pension pot without using the tax-free cash income feature, they'd need to draw £62,400 out of their pension.

That person would pay £12,400 in income tax, and if you do that for 20 years, that's £248,000 to the taxman, and £248,000 less in your retirement savings.

All tax calculation are based on 2024/25 UK tax rates.

4. Why Diversification Matters

Take Control and Reduce Your Dependency on the Business Valuation

While your business may be a valuable asset, relying solely on its valuation for your financial security can be risky. It provides your financial security now by paying you an income, is it asking too much to depend on it to provide your future income too?

Economic downturns, industry changes, or unexpected events out of your control could impact its value and the ability to sell it when you want to.

Pensions and ISAs invested in other companies around the world spreads your risk and provides an invaluable financial and psychological safety net.

Government Policy Risk

It probably hasn't escaped your attention that Business Asset Disposal Relief (BADR) has become less generous over the years.

It used to be called Entrepreneur's Relief, and at one point gave a lifetime £10m allowance of business disposals/sales, with a reduced tax rate of 10% on proceeds instead of the headline Capital Gains Tax Rate. This has reduced over time to £1m.

Capital Gains Tax rates have recently gone up, so who knows if BADR will continue in its current form?

By moving money from your business to Pensions and ISAs, you take back control of policy risk of the government of the day.

Yes, Pensions and ISA policy can also be changed, but by having money split between three pots (Business, Pension and ISA) you give yourself a much better chance of being able to absorb any changes and be flexible with where you draw capital from, as opposed to having all your eggs in one basket, subject to the whims of the Chancellor of the day!

5. Align Strategies with Business and Personal Goals

Salary, Dividends, and Contributions

Plan your income from the business to strike the right balance between salary and dividends. Use salary to make pension contributions and dividends to fund ISA investments, ensuring tax efficiency and wealth diversification.

Leverage Surplus Business Cash

If your business generates surplus cash, consider channeling it into tax-efficient investment vehicles. This approach reduces taxable profits while strengthening your personal financial position.

6. Plan Ahead for a Holistic Wealth Strategy

So what to do now?

a) Set Up a Tax Reserve Fund, Pay Yourself & Save for Your Future

Allocate a portion of your income regularly into a reserve fund for future tax payments, while ensuring other funds are directed toward diversified investments. Ask your accountant to help you estimate how much you should be holding back, work out how much you need to draw from the business to sustain your lifestyle, then invest for your future.

b) Work With a Financial Planner

A financial planner, ideally a highly qualified and independent one, who already works with clients like you, can help align your personal and business financial goals, ensuring that you maximise your opportunities for diversification and tax efficiency.

A good financial planner will also help you understand when might be the right time to move into retirement, not just from a financial perspective, but also with emotional and lifestyle factors considered.

Remember, the accumulation of money isn't all there is to it, it's using it for a life well-lived that matters.

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🚨 Take our free quiz - see how tax-efficient you are 🚨

We've designed a quiz to help you understand how tax-efficient you're being, both in the short-term and long-term.

Try it here and get personalised results for what you should do next, plus get our free guide 'The Business Owner's Guide to Financial Independence'.

Take free quiz

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The figures provided in this article are for example purposes only, investment growth figures are not guaranteed and returns will depend on a number of factors.

This is not a recommendation to invest in pensions or ISAs, as each individual's circumstances are different, it is designed to provide information and why pensions and ISAs may be appropriate.

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Jamie is Lab Financial Planning Managing Director, and a Certified Financial Planner™.

He advises business owners to help with their tax-efficient financial planning, and ensuring that they and their family are well protected, in any scenario.

If you'd like to discuss your financial planning, why not get in touch to see if we can help?

Remember, there are no stupid questions. Everyone has a different level of knowledge about money and planning their finances. We speak in plain English to help take away the fear and empower you to use your money well.

You can drop Jamie an e-mail here: jamie@labfp.co.uk

Or, you can book in a free introductory call, to discuss your situation, here: https://calendly.com/labfp/intromeeting

Permission to Spend

Let's play a quick word association game.

I say 'budgeting'. 

What connective words does your brain come up with?

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If we were playing Family Fortunes, and you said 'permission', I think very few, if any, of our audience survey will have said the same.

I don't know that for certain of course, I'm not Les Dennis.

But from my experience of conversations I have with clients about budgeting and spending on certain things, it seems that the word "budget" often carries a connotation of restriction and deprivation. 

For many, it evokes images of tough times, cutting back, and denying yourself the things that make life enjoyable. 

When done right, a budget isn’t necessarily about limiting spending; it’s about empowering yourself to spend wisely. By embracing a budget, you can give yourself permission to spend on what truly matters, without guilt or anxiety. 

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Understanding the Purpose of a Budget

A budget is not merely a tool for curbing spending—it's a framework that helps you allocate your spending in a way that aligns with your values and goals. 

Think of a budget as a personalised spending plan, designed to ensure that your money is working for you, not against you. It helps you identify your priorities, whether they be saving for a deposit on a home, travelling, investing in your education, or simply enjoying life without financial stress.

By establishing a budget, you can see clearly where your money is going and ensure that it reflects your true priorities. This clarity can be liberating, as it allows you to make informed decisions about where to cut back and where to spend, without the lingering guilt that often accompanies unplanned spending.

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Shifting the Mindset: Permission to Spend

One of the key benefits of a budget is that it gives you explicit permission to spend. 

Setting aside money for specific categories—such as entertainment, dining out, or hobbies—you’re essentially telling yourself that it’s okay to enjoy these aspects of your life and allocate both your time and money to these things. 

You’re not overspending; you’re spending within the boundaries you’ve set, which is both responsible and empowering.

For instance, if you allocate £150 a month for dining out, you can enjoy meals at your favorite restaurant without worrying about whether you can afford it. That money is there, set aside specifically for that purpose. 

The beauty of this approach is that it eliminates the anxiety that often accompanies spending because you know you’ve already accounted for it in your budget.

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Prioritising Joyful Spending

A crucial aspect of giving yourself permission to spend is identifying what brings you joy and fulfillment. Your budget should reflect your personal values and passions. 

If traveling is what makes you happiest, then prioritise it in your budget. Conversely, if certain expenses don’t bring you much satisfaction, reallocate that spending to something that does. Clearly I'm not talking about council tax here, that one's got to be paid if you want the bins taken away each week.

The concept of “joyful spending” involves focusing on expenditures that enhance your life, rather than feeling pressured to spend on things that don’t. This approach encourages mindful spending, where every dollar spent contributes to your overall happiness and well-being.

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The Balance Between Saving and Spending

While it’s important to give yourself permission to spend, it’s equally crucial to maintain a balance between spending and saving. A healthy budget should incorporate savings goals, whether they be for an emergency fund, a home move, retirement, or other long-term objectives. By doing so, you ensure that your future self is also taken care of.

The balance between spending and saving can be fine-tuned by regularly reviewing and adjusting your budget. Life circumstances change, and so should your budget. If you find yourself consistently under-spending in one category, you might consider reallocating those funds to another area that brings you more joy or towards increasing your savings.

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Practical Steps to Implement a Balanced Budget

1. Assess Your Income and Expenses: Begin by calculating your total monthly income and listing all your expenses. Categorise your expenses into fixed (rent, utilities) and variable (entertainment, dining out).

2. Set Financial Goals: Determine what you want to achieve with your money, both short-term (e.g., saving for a holiday) and long-term (e.g., retirement). Your goals will guide your budgeting decisions.

3. Allocate Funds Mindfully: Distribute your income across different categories, ensuring that you’re covering essentials, saving for the future, and allowing yourself room to enjoy life.

4. Review and Adjust Regularly: Your budget should be flexible. Review it every so often, say once a year, to ensure it still aligns with your goals and make adjustments as necessary.

5. Celebrate Small Wins: Acknowledge when you’ve successfully adhered to your budget and treat yourself within the limits you’ve set. This reinforces positive financial habits.

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Giving yourself permission to spend within a budget is about more than just managing money; it’s about reclaiming control over your financial life and using your resources in a way that maximises your happiness. 

Embrace the freedom that comes with a budget—it’s not about limiting yourself, but about living a life that’s rich in the ways that matter most to you.

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If you'd like to talk to us about your budgeting and ensuring it aligns to what is important to you, you can book in a free initial consultation here:

https://calendly.com/labfp/intromeeting

Otherwise, see you next time.

Where do holidays fit into good financial planning?

The most recently published blog, which was about navigating financial pressures, included a section about the psychological benefits of savings. 

It is fair to say I received a little bit of push-back from one or two readers (you know who you are 😀), who said that there are also psychological benefits to going on holiday (!), suggesting you can only have one or the other.

As you would expect, I argue that there is room for both!

Good financial planning is about doing all the things you enjoy doing, without jeopardising your long-term financial security.

You simply need to be mindful about how spending on holidays fits into your overall finances.

As we're in the midst of holiday season, let's look at the psychological benefits of holidays and how you can ensure you get all the benefits, without hurting your finances.

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Psychological Benefits ❤️

First, it's a good idea to remember, why do we go on holiday? 

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Considering Costs 💰

While the psychological benefits are significant and important, it's essential to consider the costs to avoid financial stress that could negate these benefits. 

Here are ways you can ensure the holidays that you love don't hurt your financial position.

1. Budget Planning: Create a holiday budget that fits within your financial means. 

The word 'budget' can conjure negative connotations, but when done right, it can actually be a permission to spend without guilt.

Plan for all expenses, including travel, accommodation, food, and activities. 

Planning can kill a bit of spontaneity, but it also helps avoid any regrets when you come back and see that you spent more than you expected!

2. Value vs. Cost: Focus on the value of experiences rather than the cost. Sometimes, less expensive holidays can offer more meaningful and memorable experiences.

This doesn't mean you can't take your once-in-a-lifetime trip or a big holiday; if it's somewhere you really want to go and are pretty confident you're going to love it and can pay for it without harming your finances, do it!

3. Avoid Debt: Try to avoid financing holidays with debt. The stress of repaying high-interest credit cards or loans can overshadow the benefits of the holiday.

4. Off-Peak Travel: Traveling during off-peak times can reduce costs significantly. Look for deals and discounts to make holidays more affordable.

'Shoulder season' is your friend! it also usually means fewer other tourists trying to do the same things as you.

5. Local Getaways: Consider local or short-distance getaways that can offer a change of scenery without the high cost of long-distance travel.

This is especially true of places that are cheaper to get to in Europe. Do your research on up and coming places, which will welcome you with your tourism pounds, and maybe avoid the places that no longer want as many tourists!

6. Mindful Spending: Be mindful of spending during the holiday. Set a budget for spending on things you hadn't planned for, a 'free-spend' fund. You won't know what it's for in advance, but allows for spontaneity and buying tat like fridge magnets, like I do!

By balancing the psychological benefits with careful financial planning, you can maximize the positive impact of holidays on your mental well-being without the burden of financial stress.

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So, can I go on holiday then?

With my financial planner hat on, my view is: if you can afford to do it, and you think it's going to be worth it, go on that holiday!

Good financial planning is about making sure you have enough money to give yourself permission to spend on things without guilt, and that you have a good balance of living for today vs. saving for tomorrow.

That is it in a nutshell, and those two principles apply perfectly to holidays, especially the ones you'll remember forever.

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If you'd like to talk to us about your situation to see if our Financial Planning service could help, you can book in a free initial consultation here:

https://calendly.com/labfp/intromeeting

Otherwise, see you next time.