What should contractors do with their cash surplus?

You have a cash surplus; that’s great news. But what should you do with it? 

Investing your surplus is a good choice, as it can increase the money you make. But there’s a multitude of options as to how you invest it, and questions as to which part of your income you invest. Here, we guide you through the cavernous world of investing your surplus. And we hope to give you some ideas around what you could do with your surplus.

What part of your income should you invest?

You can invest your surplus from a few sources, including your profits and funds from your company’s bank account. It’s more common for contractors to invest their profits, rather than bank account funds. Keeping investments separate from your business costs helps you to reserve money that pays for things like VAT, PAYE, and Corporation Tax.

Ask yourself how much of your company’s cash is available to invest and how much you should retain in the company to pay its liabilities. Once you know this, you can decide what to do with your money.

How to invest your cash surplus

Once you’ve decided how much of your surplus you can invest, you have a few options available as to how you should invest it. The options available to you are outlined below.

1. Investing in High-Interest Accounts/Bonds

Invest your surplus in a High-Interest Account or bond, and you could earn money on interest with little effort. You can secure a higher interest rate by agreeing to tie the funds up for a specific timeframe.

But remember, that once you deposit the money, it’s tied up for the whole period. If you want to withdraw the funds before the settlement date, there are usually penalties to pay.

Investing your money this way can also make up part of your exit strategy. For example, if you have plans to stop contracting, or to retire soon. After closing your company, you can distribute profits as capital. This has tax advantages, due to the lower rate of tax in comparison to dividends.

2. Distributing your surplus as dividends

Instead of retaining the profits in your company, you could declare them as dividends. Dividends are taxed at 7.5%, which is lower than the salary rate of 40%. It’s advisable to declare dividends each tax year at least up to the basic rate threshold of £37,500.

The first £2,000 in dividends are tax-free. But what happens if your total income exceeds the basic rate threshold? In this case, there will be an additional tax of 32.5% to pay on the dividends.

It may still be of use to distribute your surplus as dividends. For example, you’ll still enjoy the benefits of the dividends received and know the level of tax that you will pay.

3. Making company pension contributions

Planning for retirement? Company pension contributions may be for you. Your company can make contributions directly into your pension fund. This could be a stakeholder scheme or a SIPP. These schemes should receive full Corporation Tax relief in the year that they are paid.

Most pension schemes are National Insurance free, which can make them a tax-efficient method of extraction. But bear in mind that it ties your money up until retirement. We advise speaking to a financial advisor before deciding on this. That way, you will get the best product for you, and ensure that you sign up to the best pension plan for you.

4. Investing in stocks and shares

Want to try and earn an additional income for your company? If you’re considering investing in stocks and shares, you must take care before you commit yourself to an investment strategy. For this reason, it’s advisable to only invest with money that you can afford to lose. This means you will be safe in case your investments don’t go as planned.

It’s usually more tax-efficient to make your investments personally. This is because you will receive an annual exemption of £12,000 in which your capital gains would be tax-free.

If you start to invest company funds, whether it’s in stocks and shares or even in high-interest deposits, care must be taken. This is because you may put your trading status at risk if you wish to consider claiming entrepreneurs’ relief in the future. You should also consider the implications if your company was deemed to be a closed investment company (CIC). This is unlikely to be the case but would be if the company was not ‘wholly or mainly’ a trading company. CIC’s are subject to the main rate of corporation tax, which is currently 19%.

Nixon Williams has a wealth of support in their resources hub to help you manage your money.