Owning a business isn’t easy: you’re in charge of finding customers, building your brand, looking after your employees, managing funds… and that’s before you consider the fact that you have to sort out your own income too!
It’s fairly straightforward for sole traders and partnerships who can simply withdraw cash from their business.
However, things are a bit more complicated if you’re the director of a limited company as you’re technically an employee of the firm. This means that you can pay yourself a salary as well as dividends – but they’re not one in the same, as they’re subject to different types and rates of tax.
In short, the best way to pay yourself is by taking a modest director’s salary and supplementing your earnings with regular dividend payments. But what’s the most tax-efficient way to go about this so that you can maximise your earnings? Keep reading and we’ll talk you through it.
Director’s Salary: What to Consider
If you strategically plan how you structure your salary and dividends, you can maximise your tax reliefs and minimise your liabilities.
Because of the influence of tax rates and National Insurance, it’s not quite as simple as paying yourself the lowest possible salary and the highest possible dividends. Here’s a quick breakdown of the tax thresholds, allowances and limits that will determine the most tax-efficient salary for you:
Income Tax Personal Allowance
The annual tax-free personal allowance is £12,570 – so you won’t pay tax on the first £12,570 of your salary. For any of your salary above this sum, you’ll have to pay Income Tax.
Current Scottish Income Tax rates are as follows:
| 19% – starter rate | £12,570 – £14,876 |
| 20% – basic rate | £14,877 – £26,561 |
| 21% – intermediate rate | £26,562 – £43,662 |
| 42% – higher rate | £43,663 – £75,000 |
| 45% – advanced rate | £75,001 – £125,140 |
| 48% – top rate | £125,140+ |
Primary Threshold for National Insurance (for employees)
As an ‘employee’, you’ll have to pay 8% National Insurance on your salary between £12,570 and £50,270, and then 2% on any salary above this.
Secondary Threshold for National Insurance (for employers)
As an ‘employer’ (even if you have no other employees), your company will pay 13.8% National Insurance on your salary above £9,100.
You’ll have noticed that this means you’ll be paying national insurance twice – once as an individual, and once as a company
Lower Earnings Limit
In order for you to earn credits towards your state pension, your annual salary will need to be £6,396 or more – otherwise, that year won’t qualify.
Eligibility for Employment Allowance
If your limited company qualifies for the Employment Allowance, you may be able to reduce the amount of National Insurance that your business has to pay annually by up to £5,000. You’ll need to have at least one other employee earning more than the Secondary Threshold for NI.
The Most Tax-Efficient Director’s Salaries
Based on these considerations, here are the three director’s salary options that we’d recommend.
*Please note that these options are generalisations; actual recommendations will depend on your specific personal circumstances and earnings and your business circumstances and profits
Option 1
Use this strategy if: you own a one-person Limited Company, are not eligible to claim the Employment Allowance, and want minimal administration.
What you could do: pay yourself a salary low enough that you won’t pay Income Tax or National Insurance, but high enough that you’ll be entitled to State Pension and NIC benefits.
Option 2
Use this strategy if: you own a one-person Limited Company, are not eligible to claim the Employment Allowance, and want the most tax-efficient option.
What you could do: pay yourself a salary low enough that you won’t have to pay Income Tax or employee NIC, but high enough that you’ll pay employer NIC – thanks to Corporation Tax savings, this will still be tax-efficient.
Option 3
Use this strategy if: your business is eligible to claim the Employment Allowance.
What you could do: pay yourself a salary high enough that you’ll pay NIC as an employer, but use your Employment Allowance to reduce annual NIC liability, and stay tax-efficient thanks to Corporation Tax savings.
Paying Yourself Dividends
Dividends can supplement your director’s salary to make it up to your ideal income. Your business must be making a profit after tax in order to pay dividends, and while they are not subject to National Insurance, they are taxable, albeit at a different rate to Income Tax:
Dividend Tax Rates
The tax-free allowance for dividends is now £500, so for any dividends greater than £500 you’ll have to pay personal tax rates which are dependent on the Income Tax band that you fall into. To work out this tax band, add your gross dividend income for the year to your other sources of income (e.g. your salary).
Current UK dividend tax rates (which also apply to Scotland):
| 8.75% – basic rate | £13,070 – £50,270 |
| 33.75% – higher rate | £50,271 – £125,140 |
| 39.35% – additional rate | £125,140+ |
Balancing Business Needs with Personal Compensation
When deciding how much you want to pay yourself between your salary and dividends, the most important things to consider are the needs of your business and your own individual needs. You should make sure that you leave enough funds in the business to cover all business liabilities while paying yourself a fair wage.
Resources
Checking the HMRC website regularly will ensure you stay on top of any changes in tax rates or thresholds. There are also online profits calculators like this one to help you work out how much tax you’ll incur on any combination of salary and dividends.
However, the easiest and most stress-free way of making sure you’re paying yourself as tax-efficiently as possible is getting professional advice. Our team of accountants can advise you.
