12 Unique Advantages of Setting Up a Limited Company – Ad | This is a paid partnership with PensionBee but all words and ideas are mine.
We recently shared 10 things you should do before you start your business or your side hustle.
Today, I want to follow that up and actually talk about legal structures, particularly a limited company, and its advantages.
When you start a business, you can either start as a sole trader or a limited company.
Now, I have to admit straight away that starting as a sole trader is the easiest way to actually begin.
But starting as a limited company has some game-changing advantages, which I want to cover with you guys today.
What Is a Limited Company?
A limited company is a legal entity that offers the owners a separate identity from the company itself.
This is usually known as the “veil of incorporation” as it symbolises the distinction between the company and its owners or shareholders.
As a result of having separate identities, the limited company is able to offer some unique advantages to those starting a business or a side hustle.
12 Unique Advantages of a Limited Company
Here are the 12 limited company advantages:
1. Pension Contributions
The first advantage of a limited company is that of company pension contributions.
If you've got a limited company, you can make employer contributions to your pension and they will generally be classified as an allowable business expense.
You also need to have a pension scheme like a private pension set-up.
Any pension contribution from that limited company to yourself is generally treated as a tax-deductible expense.
i.e. You pay no corporation tax on that pension contribution as a business.
That's because, for a limited company, pension contributions are treated just as an expense like other costs such as marketing or advertising costs.
Employers also don't pay employers' National Insurance on pension contributions.
On top of that, because you didn't pay it to yourself as a salary, you're not incurring any income tax upfront.
That money can then be invested many years into the future and when you do come to withdraw from your pension, you get 25% of it tax-free.
This is a massive advantage of a limited company over operating as a Sole Trader.
The pension contribution is also not linked to your income.
So you can earn, say, a small salary but be able to make an employer contribution of up to £40,000 a year into a pension from your limited company.
To get started, open up a self-employed pension with PensionBee.
They can also help you to consolidate any old work pensions for free into one simple online plan.
2. Pay Yourself Tax Efficiently
Here I'm talking about how you choose to pay yourself.
With a limited company, you can pay yourself a combination of salaries and dividends.
You can take up to the tax-free personal allowance of £12,570 and the rest of the money you can pay yourself as a dividend.
Dividends are taxed at a much lower rate relative to salaries if you took that as income.
Here is how dividend tax rates compare to income tax on salary:
- Basic Rate – 8.75% vs 20% for salary
- Higher Rate – 33.75% vs 40% for salary
- Additional Rate – 39.35% vs 45% for salary
This is completely legal too!
You also get a tax-free dividend amount of £2,000 per year for dividend income.
In addition, you don't pay National Insurance on dividends compared to if you'd taken that amount as salary.
To learn more about how to pay yourself tax efficiently via a combination of salaries and dividends, watch this:
3. Tax Planning
With a limited company, after paying your corporation tax, you can retain profits within your balance sheet in that business in the retained earnings section of your balance sheet.
This means that you can choose when you actually withdraw that money as dividends.
You don't have to take everything out in the current tax year.
e.g. If you maxed out your allowances this year, you can wait until the next tax year before you choose to pay yourself from that business.
This flexibility gives you the advantage of being able to plan from a tax perspective.
4. Limited Liability
As mentioned before, when you have a limited company, you have two separate entities i.e. you and the limited company.
This gives you an important advantage because it protects you from personal liability against any debts the company might have.
Provided there's no fraud or anything like that involved, no one's going to come after your personal assets or come after your house.
When compared to operating as a sole trader, you don't have that advantage.
The other really important advantage related to this is that of shifting risk.
If you have money in one limited company and want to use that wealth to acquire assets, that limited company can legally lend money to another limited company.
This is usually done via an arm's-length loan agreement and that money can then be used by the other limited company (e.g. a holding company) to invest in assets such as property.
This way you're diversifying into other assets whilst also reducing your risk.
Please seek advice from an accountant and tax adviser and make sure that everything you do is within the law.
Raising money for business purposes can be pretty difficult if you are an individual.
But if you've got a limited company, because you've got that separate legal entity, it's a lot easier for you to get funding for your business.
This is also a reason why a lot of people choose limited companies as a way for them to invest in property.
They can create a business case for investing in property and thereby present that to the bank to obtain a mortgage for property investment purposes.
Overall, funding becomes easier compared to if you were doing this by yourself as a sole trader because that limited company has a distinct legal entity of its own.
6. Name Protection
If you've got a limited company and you've got a name that you registered at Companies House, that name is actually protected by law.
i.e. Nobody else can use it provided when you registered it, no one else was using that name in the first place.
However, if you operate it as a sole trader and name your business, somebody else could actually go ahead and register that name as a limited company.
7. Different Share Classes
The advantage here is that you can create different share classes.
These are known as ‘Alphabet' shares and can be set up as A-Shares, B-Shares, C-Shares, etc.
But why bother?
With different share classes, you can have different people have different ownership rights of a limited company.
One advantage is that people can easily sell their stake or transfer it to somebody else if there was ever a need to do that.
Another important reason for people who go into business as partners or husband and wife with a 50:50 share.
Provided they both work properly in the business and are both fee earners, you can create two different share classes with different rights.
Doing this could help with declaring dividends at different times, for example, if there was ever a need to do so.
But it's worth noting that you must make sure that the admin setup for this is done properly with an accountant and that everything is according to the law.
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With life, anything can happen. People can pass away or move on from businesses.
Having a limited company in such situations usually gives you much more flexibility.
It's a lot easier to transfer ownership in the event that one of those things happens.
Again, this is another reason why some people choose to invest in certain assets in a limited company structure.
E.g. It's much easier for them to pass on those assets to their children potentially.
Another advantage tied to this is that you can actually pay for life cover for employees or for directors of a limited company directly from the limited company itself.
9. Business Expenses
This is one of the most popular reasons for using a limited company.
You can deduct allowable expenses incurred for your business provided it's wholly and exclusively for the purposes of your business.
Doing this reduces the profit that you made that becomes subject to corporation tax.
This is important because it means you're in effect giving yourself a refund when you incur business expenses.
All of this is completely legal of course and you can even see a list on the government's website.
You should also consider seeking independent advice from a qualified accountant.
Watch the video below for more on taxes and examples of allowable expenses for your business:
You get so much more credibility if you run a limited company compared to if you just ran the business as a sole trader.
Nothing wrong with running as a sole trader, of course.
It even goes up a notch when you run a limited company and you are registered for VAT, which you can do voluntarily.
That credibility comes from speaking with banks, other lenders, potential shareholders, customers, etc.
People take you so much more seriously because they can see it is a legal entity in operation as a limited company.
11. You Can Set Up a Dormant Company
If you have an idea for your business or side hustle and a great name but not yet ready to start, you can set up a dormant company.
“Dormant” means that your business has no material accounting transactions during the year.
Setting the company up means that you protect the name from someone else using it whilst you explore your business idea further.
12. Retain First-Time Home Buyer Status
You can use a limited company as a first-time buyer to buy a property for investment purposes and still retain your first-time buyer status.
I bring this up because many people struggle to decide whether they should buy their first home or buy an investment property first.
It's worth noting that although it is possible to get a mortgage via a limited company without owning your own home first, it is a lot harder.
What Are The Disadvantages of a Limited Company?
There are also disadvantages to starting with a limited company but the advantages far outweigh the disadvantages.
1. It Costs Money To Run a Limited Company
There is a lot of admin to running a limited company and this takes time and costs money.
If you're starting a business and your goal is to make over £50,000 per annum, then a limited company structure is one that could work in your favour.
2. Complex Administration
When you compare the admin of a limited company to a sole trader, the former is more involved and complex.
A sole trader only needs to produce a set of accounts and file a tax return annually and pay the tax due.
For limited companies, there is much more to do including:
- Notify Companies House of any changes to your company as they occur,
- File accounts even if your company is dormant or not trading,
- Submit a ‘Confirmation Statement' annually with Companies House
- File annual accounts with HMRC and submit a corporation tax computation.
Note that you have to do this for each limited company that you run and the costs can start to add up.
So your business activities have to be worthwhile enough to cover these costs.
You can of course outsource all this to an accountant, which is recommended.
Expect to pay typically £800 to £1,500 per year to have these admin tasks done by an accountant.
3. Public Record of Your Filing history
As a director of a limited company, information about you and your business is available easily online to view or download.
People can see your history as a director and can even see your financial accounts, etc.
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Starting a business as a limited company can seem daunting but a lot of the disadvantages can be managed or outsourced.
The key thing is to focus on starting a business that you'll enjoy running whilst adding value to others and earning more in the process.
What questions do you have about starting a business as a limited company? Please comment below.
What To Read Next:
- Open a Self Employed Pension With PensionBee
- Pensions Explained UK: Ultimate Guide For Beginners
- How To Start a Business UK: 10-Step Guide
What To Watch Next:
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.