If I build up a significant balance in my business account, can I pay myself a modest salary for a few years if I stop contracting?

Hi,

looking to see if the above is legit / feasible?

Context:
I’m currently a full-time employee (approaching 50) and am considering leaving my current employment and going solo as a contractor (using a Limited company structure) up to retirement. I have a lead for a contract that I intend to secure before leaving my employment (if I go ahead). And hopefully continue to get other contracts from there on.

We are in a fortunate position that our mortgage is paid-off and we have no outstanding debt (we lived frugally (relatively) – drove old cars etc. and prioritized mortgage overpayments for many years over lifestyle / luxuries). So, I aim to keep my new salary as low as possible in the first few years to build up a balance for investments (which hopefully will also grow over time). And use these investments to make up the shortfall in future salary payments as I whittle down my working days per week as I approach retirement. (of course, not all may go to plan)

My ideal scenario would be as follows:

• Start contracting 4 days per week for the first four years
• Reduce to 3 days per week for a few years
• Reduce to 2 on average for a couple more (yes, I’m being kind to myself! – I’ve spent decades doing dogged hours and lots of travel, so I plan to gradually taper down my work week)
• A few years without contracting but hopefully have sufficient balance to pay a modest salary for these years (if this can be done) – until my pension kicks in.

I will mockup a scenario to demonstrate my thoughts a little further:

• Projected income for year: €120,000
• Salary €42,000*
• Expenses €10,000
• Taxable @12.5%: €68,000
• Corporate tax: €8,500
• Remaining balance / Available to invest: €59,500

*I know €42K is not much to live on but have also some personal investments that I can tap into if needed – not a lot but should help as a fallback, and could also increase my salary above if needed.

Assuming 4% annual growth rate, after 4 years, the investment value would be €252,239

My intention would be to start to use this fund to make up the shortfall in pay (when working fewer days per week) and to pay myself a modest salary when not contracting.

Note: I know that investments can go the other way etc., however for the purpose of this question, I’m going to run the with assumption of 4% annual growth rate on average.

I also understand that I would be paying tax again (after paying the corporate tax), but I believe this would balance out as I would be buying shares after paying 12.5% corporate tax, instead of buying shares after 52% personal tax (so would build a bigger fund more quickly).

So, my overall question is – can I build up a balance in a limited company business bank account (and pay corporate taxes along the way), and pay myself a modest salary for a few years while not contracting? (and as mentioned in the above, I may use some or all of the balance for investments in the first few years).

Any feedback appreciated.

Yes, you can, but it would be very hard to see it working out tax efficiently.

I am not a tax expert, but your non-trading income would be subject to a surcharge as well as C.T.

And you would be taxed on it when you take it out.

It might work if you were paying 53% taxes on your income one year and 0% the following year. But I would not base a long-term strategy on it.

Any Capital Gains made by your shares would be taxed at 33% in the company and the remaining 67% would be taxed again at a rate of at least 33% when you take it out of the company.

So if you take the money out now and invest it, you will still get the 4% a year return and you will pay CGT only once and may be able to avail of other personal exemptions.

Brendan Burgess said:

your non-trading income would be subject to a surcharge as well as C.T.

Click to expand...

This can be avoided by investing in a life company investment policy. There's a lower tax charge on an investment owned by a company, think it's 25%.

The issue of tax on removing funds from the company still exists, but it seems like OP is aware of this and willing to pay it. Pension contributions would still be a good idea.

Fortune said:

Pension contributions would still be a good idea.

Click to expand...

Yes, I had meant to suggest this, especially given his age.

Thank you Brendan and Fortune for your prompt responses - these were helpful.

I would like to tease this out a little further and I’m going to simplify the scenario I used above and park the investment options / pension contributions for a moment.

So, say my objective here is to have sufficient funds in my business account that I can pay to myself as a salary in the last 3 years on the run up to retirement - without having to work - ha! "the best laid plans of mice and men" comes to mind.

Option 1 is I pay the full amount to myself as a salary in Year 1 (3 years out from retirement)

Option 2 is I pay the remainder over 3 years, and pay the additional capital gains tax too.

By my calculations, my nett take home would be far higher with option 2, despite also having to pay CG tax. Unless my calculations are wrong – which is very possible

Let me use figures to demonstrate. To simplify, let’s assume expenses are zero in both scenarios.

So, say I have €126k in my business bank account 3 years out from retirement. I would take home 20K extra with option 2 if my calculations are right

Option 1 – pay full amount as salary in one go:



Option 2 – pay over 3 years along with CG tax:

If you have excess taxable income in one year and you are certain that you will have no taxable income the following year, yes, it makes sense to spread the income over two years.

It's even better than you calculate.

In Year two, you will make a loss of €42,000 for Corporation Tax purposes and so will be able to set that loss back one year and get a refund of Corporation Tax - 12.5% of €42,000 ( I'm assuming there are no restrictions on the company having ceased to trade.)

Check with your tax advisor if there is a surcharge on the undistributed professional income - I don't think that there is.

manachan said:

• Start contracting 4 days per week for the first four years
• Reduce to 3 days per week for a few years
• Reduce to 2 on average for a couple more (yes, I’m being kind to myself! – I’ve spent decades doing dogged hours and lots of travel, so I plan to gradually taper down my work week)

Click to expand...

It does not really work in your original scenario because you will have taxable income for the next years so deferring it will not be tax-efficient.

Max your pension contributions or take the money out and invest the net proceeds.