Investing company money that has built up within a business bank account poses a challenge to many company directors.
If you are a dentist that has decided to incorporate (or perhaps you’ve already done it), or a doctor with private earnings that has incorporated, one of the main differences you’ll have noticed is that there is now another party in your business life.
The Limited company. #
Beforehand, life appeared to be simple. You earned your net profits, your accountant prepared your accounts and then informed you how much tax you had to pay in January and July. The after tax net profits were yours to keep and you would usually save any excess in a savings account, offset mortgage or allocate it to investments such as ISAs and pensions.
How easy it all was!
Since you set up your Limited company (which you now work for as you’re an employee), on the advice of your accountant your salary has reduced to a little over £5,000 pa and, as you feel you might struggle to live on this, you are also receiving dividends each month, as well as periodic dividends as and when required.
But wait a minute, prior to setting up the Limited company your net profit was £150,000 pa and the turnover of the business has actually increased slightly since then.
Where has all the money gone?!
Of course, as you’ll know the answer is that it’s still there.
The difference is that it sits within the Limited company bank account. The company has its own tax rates (corporation tax) and your accountant is the best person to advise you with regards extracting profit from it.
But one question we’re being asked more is what to do with the cash that sits within the company?
Where can you put it to get a reasonable rate of return?
The starting point is to realise that the savings/investment choices of a Limited company are not too dissimilar from your own as an individual.
Whilst we can’t cover all the options today, let’s take a look at some of the main ones.
1. Deposit Savings Account
It’s likely that your business bank also offers a range of savings accounts in addition to the normal day to day business bank account.
Our view is that it definitely pays to shop around here. Like with accounts available to you on a personal basis the rates are not high at present, however it’s probable that you’ll be able to improve on what your bank is offering.
At the time of writing, one major business bank is offering 1% pa AER, whilst a deposit account elsewhere is available at 2.19% pa AER. With the latter you need to save over £50,000 and give three months notice to withdraw any money, so only go for this if you don’t need instant access to your cash.
The account’s operated by post or over the phone, and has a maximum allowed balance of £250,000.
I recommend you do your own due diligence and compare what’s on offer in the market. It’s well worth the effort, as an additional 1% pa return on a balance of £100,000 equates to £1,000 pa.
This can be considered ‘easy money’, especially if you consider that it’s entirely possible that you will retain a reasonable sum of cash in the company on an ongoing basis (obviously, these rates are gross and tax will be due on the interest).
A word on protection.
As you’ll be aware (I think we all are after the banking crisis!), when saving money on a personal basis the first £50,000 of your savings are protected per banking licence.
If your company turnover is less than £1m pa, the company has the same amount of protection for money saved in UK registered banks. So, if you’re saving more than £50,000, you may want to spread it between different accounts (although the number to choose from is not as extensive as on a personal basis).
If the turnover is more than £1m, there is no protection at all. One way in which you can at least mitigate some of the risk is to spread your money between as many accounts as possible to at least diminish the chances of losing your money.
2. Investment Bonds
With an investment bond you invest a lump sum over a minimum period of 5 years (recommended, but not compulsory).
The bond is simply the ‘tax wrapper’ – the money will actually be invested in assets such as equities (shares), government bonds or cash. You decide where the money goes.
Just make sure you understand the risks before you write the cheque. In addition, as the recommended minimum investment period is 5 years, make sure you don’t need access to these funds in the meantime.
It’s worth noting when you’d pay tax on the investment, as the rules changed recently (effective from the company’s first accounting period on or after 1 April 2008).
If your Limited company operates on a ‘fair value’ accounting basis, corporation tax will be due on any increase in the value of the bond from one year to the next.
Companies that apply the ‘historic cost’ accounting basis will continue to benefit from tax deferral in respect of the bond. This is due to the fact that only the original value of the investment is normally shown on the balance sheet each year until the bond is encashed or otherwise comes to an end and a profit has arisen.
If your Limited company does operate the historic cost basis, you will have tax planning advantages as you will be able to control the point at which tax is paid. You’ll also be able to control cashflow by taking profits from the bond in a year in which overall profits are lower.*
3. Pension Schemes
As an employee, you are entitled to make pension contributions and receive tax relief at your highest marginal rate. You are entitled to contribute up to 100% of your income providing the income does not exceed £130,000 pa. If it does, restrictions currently apply to limit contributions to £20,000 – £30,000 pa (these anti-forestalling rules are quite complex, which we don’t have time to cover).
However, if your salary is now very low due to your new remuneration structure, you will only be able to contribute 100% of that amount to a pension scheme (we’re ignoring the NHS Pension Scheme here, this relates to a private personal pension type scheme).
A bit of a ‘catch 22′…
Well, one solution is to have the company pay the pension contribution on your behalf. The advantage is that there is no upper limit to how much can be contributed, although you need to make sure you follow the ‘wholly and exclusively’ guidance from HMRC.
Above all, make sure you take professional advice before you take any action.
Key Considerations:
There are a number of options available to the Limited company owner. From leaving the money in cash to investing with more risk (and potentially a greater return) the business owner has a number of decisions to make.
Action Point
As you’ve probably done with your own personal affairs, take the time to research your options to enable you to make better decisions regarding the ongoing management of the company’s (your) money.
# Click here and here for articles on the financial and legal aspects of setting up a Limited company for dentists.
* Source: Scottish Widows techtalk June 2010
