Dividends – An opportunity or costly trap?

It has become almost fashionable these days for company shareholders to have organised the company share ownership, so that they and their spouses jointly own shares in their unquoted company. They then, usually on their accountant’s advice pay themselves the minimum wage to attract National Insurance contributions at a very low level and then take the rest of their remuneration in the form of dividends. We believe this to be a trap which most people would do well to consider at length before embarking on this course of action.

Firstly, and probably the most costly, is the inability to build up significant pension rights in either the state or private sector. Many entrepreneurs “do not believe in pensions” and that their pension is their business. That is probably because no one has explained the considerable flexibility and opportunities that a pension offers. A corporate planning specialist rather than a conventional adviser would be able to demonstrate how to use your company pension as a planning tool. It is also useful if wishing to purchase commercial property at a discount.

Secondly the loss of the state second pension (because this is calculated on average earnings which do not include dividends) is also a loss greatly underestimated by most accountants and directors. If a director were to pay himself at least the upper earnings limit every year then he or she would benefit at retirement from the state second tier pension.

So what? Well that to fund that privately would mean that you would have to contribute sufficient monies to create a fund of approximately £450,000. This is a benefit that many advisers (who should know better) ignore. Oh well, say advisers, look at the cash flow advantages of taking dividends. Short term decisions that have long term implications for directors should not be taken lightly.

Therefore a mix of dividends and income is generally to be preferred with at least the upper earnings remit for the state second pension being paid as a salary or bonus. The net difference between dividends and salary/bonuses is rather less than 2.4% shared between you and the company bearing in mind that company gets tax relief on the salary and on the National Insurance contributions which it pays.

In our opinion companies would be well advised to examine the advantages of a share incentive scheme or even consider a specialist trust arrangement. Taking advantage of these arrangements would provide for long term cash flow advantage and also provide a flexible stepping stone for other planning.

Remuneration strategies form part of the Total Planning System™ and should be considered by all share owning directors.

About Ray L Best

Ray Best has had over 30 years experience of advising on complex financial matters. A published author of a number of books including “Partnership and Shareholder Protection”, Inheritance Tax Simplified”. We provide an initial meeting at no cost and only engage with clients when we can add significant value.

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