Keeping profits in your business instead of taking them out? That's retained income at work. This approach affects your tax position, your company's financial health, and your personal income strategy.
Many business owners don't realise how powerful this tool can be for managing tax efficiently. Understanding the difference between what you earn and what you withdraw helps you plan smarter.
In this article, we'll cover what retained income means, why it matters for tax, and how to use it in your business planning.
What exactly is retained income?
Retained income is profit your company earns but doesn't distribute to shareholders or owners. Think of it as money that stays inside the business rather than being paid out as dividends or drawings.
It appears on your balance sheet and builds up year after year unless you decide to withdraw it. Companies often keep income back to fund growth, buy equipment, or build a financial cushion.
It's different from your salary or dividends, which are personal income you've actually received. This distinction matters because tax is calculated differently on each type of income.
How does keeping profits in your business affect your tax?
The company pays corporation tax on its total profits, whether you withdraw them or not. Currently, UK corporation tax rates depend on your profit level, with most companies paying between 19% and 25%.
Money you keep in the business isn't taxed again until you withdraw it as salary or dividends. Taking dividends later triggers personal tax based on your income tax band at that time.
This creates a planning opportunity where you can time withdrawals to reduce personal tax. Keeping profits retained can mean lower immediate tax compared to taking everything as salary.
Why do business owners choose to retain income?
Building cash reserves helps your company weather quiet periods or unexpected expenses. Additionally, funding expansion or investment without borrowing keeps you in control.
Managing your personal tax position by controlling when you take income is another key benefit. It also demonstrates financial strength to lenders, suppliers, or potential buyers.
Furthermore, creating a buffer protects you if personal circumstances change. This gives you flexibility to draw income in tax-efficient ways across different years.
What's the difference between retained income and reserves?
Retained income is the accounting term for accumulated profits over time. Reserves can include retained income plus other items like share premium accounts, and both appear in the equity section of your balance sheet.
The terms are often used interchangeably in everyday conversation. However, for tax purposes, it's the retained income figure that tells you how much profit could potentially be withdrawn.
Your accountant can show you exactly what's available without creating tax complications.
Can you take retained income out later in a tax-friendly way?
Yes, but you’ll need to plan withdrawals based on your personal tax position each year. Dividends are usually more tax-friendly than salary if you’ve already taken a small salary.
Spreading withdrawals across tax years can keep you in lower tax bands. Consider timing large withdrawals when your other income is lower, perhaps in semi-retirement. Taking a cash dividend results in a cash outflow from the business, reducing cash assets and impacting the company’s financial position.
Some directors use retained income to manage tax around significant life events. Always check the dividend allowance and income tax thresholds before making distributions. When making distributions, note the difference between cash dividends and stock dividends: a cash dividend reduces both retained earnings and cash reserves, while stock dividends transfer retained earnings to common stock without a cash outflow, affecting share value and overall equity.
What happens to retained income if you close your company?
When you wind up a company, retained income is typically distributed to shareholders. Mature companies often accumulate larger retained income balances, which can result in substantial distributions upon closure. This distribution may qualify for Business Asset Disposal Relief, previously known as Entrepreneurs’ Relief.
If eligible, you could pay just 10% capital gains tax on qualifying amounts. There are strict conditions, including holding shares for at least two years.
Professional advice matters here as the rules changed significantly in recent years. Planning ahead can save thousands in tax compared to rushed closure decisions.
How do you track retained income properly?
Your annual accounts will show the company's retained income in the equity section of the balance sheet for each specific period, such as a fiscal year. It’s calculated by adding current year profits to previous years’ retained earnings, then subtracting any dividends or distributions you’ve already taken.
Most accounting software updates this automatically as you record transactions, helping you track the accumulation of the business's profits over multiple periods. Regular reviews with your accountant help you understand what’s truly available to withdraw.
Keeping good records throughout the year makes this process much smoother.
Financial reporting and retained income
Accurate financial reporting is key to managing retained earnings and building trust with investors and other stakeholders. The retained earnings account appears on your company’s balance sheet, specifically in the shareholders’ equity section.
Each accounting period, changes in retained earnings are also shown in the statement of changes in equity, reflecting the impact of net income, losses, and dividend payments.
Using the retained earnings formula ensures your financial statements are consistent and transparent. Clear reporting helps demonstrate your company’s financial stability and supports investor confidence, which is vital for long-term growth.
Businesses should ensure their financial reporting practices comply with accounting standards and provide a true picture of their retained earnings balance. This transparency not only helps with internal decision-making but also reassures shareholders and potential investors about the company’s ongoing performance and equity position.
What about tax if you're a sole trader rather than a company?
Sole traders don’t have retained income in the same way limited companies do. As a sole trader, all your profits are taxed as personal income regardless of whether you withdraw them, so you can’t leave profits in the business to delay personal tax. Profits are calculated after deducting the cost of goods sold and other business expenses, meaning that goods sold directly impact your net income and the amount subject to tax.
This is one reason many growing businesses eventually become limited companies. The ability to control when you take income and pay personal tax offers more flexibility.
If you’re considering this change, chat with an accountant about the pros and cons for your specific situation.
Get help managing your tax position
Retained income gives you control over when and how you draw money from your business. The tax side works in your favour when you plan withdrawals thoughtfully rather than taking everything immediately.
Working with good tools and advice helps you balance business needs with personal tax efficiency. Review your company accounts to see how much income you've retained, then explore whether your current withdrawal strategy makes sense.
Pie is the UK's first personal tax app, helping working individuals manage their tax responsibilities. It's the only self assessment solution offering bookkeeping, real-time tax calculations, simplified returns, and timely expert guidance all in one place.
Getting this right doesn't require complicated schemes, just good planning and awareness of how the tax system works.
Ready to take control of your tax planning? Visit Pie to see how we can help you manage retained income and tax with confidence.
