When it comes to remuneration, company directors can choose to pay themselves with a salary, dividends or a combination of both.
It can be beneficial for directors to take a combination of salary and dividends as:
- dividend tax rates are lower than income tax rates
- taking a salary keeps NIC up-to-date
- there is no NI due on dividends
- a salary can reduce Corporation Tax and help utilise your NI employer’s allowance
Of course, it all comes down to your individual circumstances as to what combination is the most profitable. It’s important to weigh up the many factors involved to find your most tax-efficient ratio of salary and dividends. We hope this article gives you useful pointers to do just that.
If you are considering taking dividends from your company profits along with a salary, it should be done after taking proper advice from an accountant. Archimedia Accounts are trusted tax experts and can advise on how to pay yourself in the most tax-efficient way. Please get in touch to find out more.
What are the different ways a director can pay themselves?
There are several ways for a director to pay themselves: salary, dividends, allowable business expenses and a director’s loan. Employing and giving shares to family members can be alternative ways to extract value from a business.
This blog will concentrate on the combination of salary and dividends.
Salary
For many directors, it’s wise to take a salary but keep it at a low level. As well as minimising your income tax burden, it can ensure you remain eligible for benefits like the state pension and also save your company money on tax and via the employer’s NI allowance.
How much salary should directors take?
The NI lower earnings limit is £533 per month (£6,396 per year – 2023) – so that is the minimum salary required to retain access to benefits such as the state pension.
In order to avoid paying National Insurance Contributions (NIC), it’s important that your salary doesn’t exceed £12,570, as this is the new NI threshold (since July 2022, when it was brought in line with the personal allowance). If you remain below £12,570, no NI is due, but you still retain the benefits.
It’s also important to factor in your NI employer’s allowance, which allows you to reduce your company’s NI liability by up to £5,00o per year.
Note: when considering your salary vs dividends ratio, another important thing to factor into your calculations is that the basic rate of income tax is due to be reduced from 20% to 19% in April 2024, as announced in the 2023 Spring Budget.
When to take a higher salary
As discussed above, it’s usually more beneficial to take a lower salary, but there are some exceptions, such as:
- Where you can’t take dividends (e.g. when your company is not in profit) or have an agreed or fixed amount of value to take out of the business (e.g. directors in investor-backed businesses).
- If you are heavily involved in research and development (R&D), your salary can qualify for enhanced relief against Corporation Tax, making it more efficient to pay a higher salary.
- The Employment Allowance (a £5,000 allowance against employers’ NI, provided the total secondary class 1 NIC liabilities are below £100k in the previous tax year) could make a higher salary worthwhile if it avoids incurring employers’ NIC.
- If you are over the state pension age, you will not pay NI contributions, making a higher salary more attractive.
- If you are looking for a mortgage or to re-mortgage (or take any other personal loan), some lenders will base their credit score on employment income (rather than dividends).
Is it beneficial to employ a family member?
It’s worth employing a spouse or civil partner if they have a lower overall income than you. That way, the individual can use their personal allowance, and the company can make a NI saving. For a single-employee company, employing an additional employee may also make the NI Employment Allowance available.
If you take this route, it is important that their pay can be justified in terms of actual activities on behalf of the company.
What are the benefits of taking a salary?
To summarise, the benefits of taking a salary include:
- Keeping your NIC topped up to retain maternity benefits, state pension etc.
- Using your full tax-exempt personal allowance, which is important if you don’t have any other taxable income. If you’re not utilising your basic rate band, then even if you’ve got a salary elsewhere, taking a second salary up to the basic rate band may be beneficial.
- Even if you are over the basic rate band, a salary is a tax-deductible expense. Therefore, it can reduce your company’s taxable income, thus reducing its Corporation Tax liability.
- If your company isn’t utilising its employer’s NI allowance, taking a salary could help you to reach the threshold and save your company money (up to £5,000 each year).
What are the drawbacks of taking a salary?
A salary is not beneficial for everyone. Drawbacks include:
- In many cases, there are no tax savings to make it worthwhile, but it depends on your particular situation, e.g. what NI band and tax bracket you are in.
- A large salary would reduce your company’s salary which may be unattractive to a lot of lenders.
Dividends
Dividend payments are simply a distribution of profits to shareholders of a company. It’s important to remember that the business must be making a net profit (i.e. after tax) in order to pay dividends. After salary, dividends are the most common way to withdraw cash from the company.
How much tax do you pay on dividends?
From April 2023 to April 2024, £1,000 of dividends are tax-free, so where possible, it’s beneficial to use this allowance in full. Note that the allowance drops to £500 from April 2024, making dividends rather less favourable than in recent years.
Dividend tax correlates to your tax bracket and is relatively low at the basic rate band, at just 8.75%. But if your total income is more than £50,270, that pushes you into the higher rate band, where dividend tax jumps to 33.75% and then 39.35% once you reach the higher rate tax band. While this is lower than the income tax rate, it’s still considerably high.
Before taking a dividend, there are other tax planning options to be considered with the help of a tax specialist. Say you want to extract cash from the business to invest in property, a car, or a new business venture; there may be better ways to do it from a tax perspective, such as through pension contributions or a family investment company.
Note: when considering your salary vs dividends ratio, remember that the dividend allowance (i.e. tax-exempt amount) is due to decrease from £2,000 to £1,000 in April 2023 and to just £500 in April 2024.
How are dividends paid?
Dividend amounts must be voted by shareholders and directors by way of a board meeting. Once agreed, dividends are paid out of a company’s profits, typically by way of cash or stock. Alternatively, a company may opt to distribute dividends in the form of additional shares of the company.
Can you give shares to your family members?
It may be worth giving some shares to your spouse/civil partner if they are in a lower tax band than you. This means they will be able to use the £1,000 tax-free allowance, saving you money overall as a couple.
You can also gift shares to children (over 18), but this impacts your Capital Gains Tax liability.
What are the benefits of drawing out dividends?
To summarise, the benefits of taking dividends include:
- The dividend allowance gives you £1,000 tax-free.
- Dividend tax is lower than income tax, so it is a more tax-efficient way to extract money from your business.
- There is no NI due on investment income, so once again, there are savings to make as opposed to just taking a salary.
- If you have to pay employees’ and employers’ NI and you are in the basic rate tax band, then there could be significant tax savings if you take dividends vs salary.
What are the drawbacks of dividends?
As with taking a salary, there are a few potential cons of exclusively taking dividends, including:
- If you’ve not used your employer’s National Insurance allowance, then taking a dividend may not be as beneficial.
- If you are taking a salary, you retain your state pension entitlement (providing you meet the NIC lower earnings limit), which you would lose if only taking dividend income.
FAQs about salaries and dividends
Although salaries and dividends are both common ways for business owners to withdraw money from their company, each has its own advantages and tax implications. Check out our FAQs here:
What is the tax-free dividend allowance?
The tax-free dividend allowance is a sum that you can take through dividends tax-free. You can draw dividends up to this amount without having to pay any tax, regardless of your other income or what income tax band you are in. The dividend allowance from April 2023 is £1,000.
Will income tax affect both salaries and dividends?
Not income tax as such, but your total income will affect how both your salary and dividends are taxed. Your overall income determines your tax band, which directly correlates to dividend tax bands.
How do you declare dividends?
Tax paid on salaries and dividends both go on your personal tax return, but salaries and dividends are taxed differently and at different rates.
How do salaries affect Corporation Tax?
The salary you decide to take out your company is classed as a business cost and reduces the company’s profit. The company pays tax on this profit, so effectively, the higher your salary is, the less Corporation Tax you pay. Note: you pay Income Tax and National Insurance on your salary at a higher rate than Corporation Tax.
Archimedia Accounts can help reduce your tax burden and maximise your pay
The team at Archimedia Accounts are entrepreneurs as well as accountants, so we have unique insight and experience when it comes to reducing your tax burden. We will work hard to understand your business and personal situation, then crunch the numbers to find your salary vs dividends sweet spot.
If you work with a great tax advisor like Archimedia, you should expect to save 3 times what you pay in fees. Get in touch with us today for a free consultation.
Conclusion
The most tax-efficient way to pay yourself as a director is a case of finding the sweet spot between salary and dividends, which is different for everyone. It all depends on your tax band, what your overall income is and if your company is using its employer’s National Insurance allowance. There are many other factors, including your family, career and life goals, so it really is a subtle balancing act.
We hope that this article provides you with a lot of actionable tax-saving tips, but to ensure you are fully maximising your business and personal income, now and for other future, it’s best to work with a keen tax specialist like Archimedia Accounts.
Learn more about how you can be tax efficient and see if you could benefit from buying a car through your limited company in our blog.
