How to pay yourself as a company director: Salary vs dividends

company director reviewing their salary and dividends
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    Did you know that as a director, you have the flexibility to pay yourself in various ways? 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 also important to weigh up the many factors involved to find the most tax-efficient ratio of salary and dividends. In this blog, our experts help you find the right balance for your situation, exploring the various ways you can pay yourself as a company director. We’ll help you weigh up the pros and cons and provide our own expertise.

    At Archimedia Accounts, we are a team of trusted tax experts and accountants with years of experience helping directors like you manage their income. We can advise you on how to pay yourself in the most tax-efficient way. So, if you’re ready to make big savings on your earnings, get in touch today.

    What are the different tax-efficient ways directors can pay themselves?

    As a limited company director, you can pay yourself in various ways, including through salary, dividends, allowable business expenses and a director’s loan. Employing and giving shares to family members can also be an alternative method for extracting value from a business.

    In this blog, we are focusing 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 save your company money on tax via the employer’s National Insurance allowance.

    How much salary should directors take?

    The National Insurance lower earnings limit is £533 per month (£6,396 per year) as of 2023 – so that is the minimum salary required to retain access to benefits such as the State Pension.

    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 tax-free personal allowance). If you remain below £12,570, then you won’t need to pay National Insurance, and you’ll still retain the benefits.

    It’s also important to factor in your National Insurance employer’s allowance, which allows you to reduce your company’s NI liability by up to £5,000 per year.

    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

    While taking a lower and more tax-efficient salary is typically more beneficial, there are some situations where you may take a higher salary. This can include being over the State Pension age, as you will not pay National Insurance contributions, or if your company is heavily involved in research and development (R&D), as your salary can qualify for enhanced Corporation Tax relief.

    If your business is not making a profit or you have agreed to a fixed amount to be taken out of your business, such as an investor-backed business, you may not be able to take dividends. In this situation, a higher salary may be more suitable as it will be your primary source of income.

    The Employment Allowance offers eligible employers a £5,000 allowance against employers’ National Insurance payments, provided their total secondary Class 1 NIC liabilities are below £100k in the previous tax year. This allowance could make a higher salary worthwhile if it avoids incurring employer National Insurance contributions.

    It is also important to note that if you are looking to purchase a property, re-mortgage, or take out any other personal loan, some lenders will base their eligibility on employment income rather than dividends.

    What are the benefits of taking a salary?

    There are many benefits to paying yourself a salary as a company director, including:

    • Receiving a fixed, regular income which helps with stability and budgeting.
    • Keeping your National Insurance contributions topped up to retain the maternity allowance and State Pension.
    • Utilising your total tax-free personal allowance.
    • Reducing taxable income for your company and reducing Corporation Tax liability as a salary is a tax-deductible expense.
    • More significant savings on the employers’ National Insurance allowance.

    What are the drawbacks of taking a salary?

    A salary is not beneficial for everyone, and some of the potential drawbacks can include:

    • Fewer tax savings in certain instances (depending on what NI band and tax bracket you’re in).
    • A large salary might reduce company profits during lean periods.

    Dividends

    Dividend payments are simply a distribution of profits to shareholders of a company.

    After salary, dividends are the most common way to withdraw cash from the company. However, it is important to remember that the business must make a net profit (i.e. after tax) in order to pay dividends.

    How much tax do you pay on dividends?

    From April 2023 to April 2024, up to £1,000 of dividend payments are tax-free. So, it’s beneficial to use this allowance in full where possible. However, the tax-free dividend allowance will drop to £500 from April 2024, making dividends less favourable than in recent years. So, when deciding your salary vs dividends ratio, this tax change should be taken into consideration.

    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, you may wish to consider other tax planning options with the help of tax specialists like our experienced accountants at Archimedia. Say you want to restructure your business to invest in property, purchase a car, or start an entirely new business venture; there may be better ways to do it from a tax perspective. This can include pension contributions or a family investment company.

    How are dividends paid?

    Dividend amounts must be voted by shareholders and directors through a board meeting. Once agreed, dividends are paid from a company’s profits, typically through cash or stock. Alternatively, a company may opt to distribute dividends in the form of additional company shares.

    Can you give shares to your family members?

    It may be worth giving some shares to your spouse or 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 the age of 18, but this impacts your Capital Gains Tax liability.

    What are the benefits of drawing out dividends?

    There are numerous advantages of receiving dividends, including:

    • Access to the £1,000 tax-free dividend allowance.
    • Less tax to pay as dividend tax is lower than income tax.
    • You won’t have to pay National Insurance on dividends, saving on both personal and employer NI contributions.
    • Potentially creates more financial flexibility for the business.

    What are the drawbacks of dividends?

    As with taking a salary, there are a few potential drawbacks of exclusively taking dividends, including:

    • Less predictable income as dividends vary based on company profits.
    • You would miss out on the State Pension entitlement and other employee benefits.

    Is it beneficial to employ a family member?

    If your spouse or civil partner earns less than you, it may be worth employing them to reduce the tax burden. Your partner can then use their personal allowance to reduce the impact, and the company can make NI savings, too. Plus, for a single-employee company, onboarding an additional employee may also make the NI Employment Allowance available.

    However, when employing a family member or spouse, their pay must be justified by their contribution to the company and the level of work they do.

    Archimedia Accounts can help reduce your tax burden and maximise your pay

    At Archimedia Accounts, we 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 the best salary and dividend ratio for you.

    Working with Archimedia can help you save three times what you pay in fees. This means our tax efficiency can enhance your business profitability.

    If you’re looking for the most tax-efficient salary to pay yourself as a company director and need professional advice from tax experts, get in touch today for a free consultation.

    Conclusion

    The most tax-efficient way to pay yourself as a director is to find the sweet spot between salary and dividends, which is different for everyone. It all depends on your tax band, overall income and if your company is using its employer’s National Insurance allowance.

    There are many other factors to consider, including your family, career and life goals, so it really is a subtle balancing act.

    The best way to get the correct balance is to work with a dedicated tax specialist like the team at Archimedia Accounts.

    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. Take a look at our frequently asked questions to learn more.

    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, meaning the higher your income, the higher your overall tax liability.

    How do you declare dividends?

    There are a few steps involved in declaring dividends, and the absolute first step is to hold a directors’ meeting to agree and record the dividend payments. Then, you’ll need to file all corresponding paperwork listing who receives dividends and how much, and these documents must be kept for your company’s records. You will then need to pay tax on your dividend payments through a personal tax return.

    How do salaries affect Corporation Tax?

    The salary you decide to take from your company is classed as a business cost and reduces the company’s profit, which your company is expected to pay tax on. So, effectively, the higher your salary is, the less Corporation Tax you pay. However, you pay Income Tax and National Insurance on your salary at a higher rate than Corporation Tax.

    Do you pay income tax on dividend income?

    You are generally required to pay income tax on dividend income that is above the dividend allowance, which is currently £1,000 (April 2023 to April 2024). The amount of tax you pay will depend on your total income and your tax bracket.

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    Chris Demetriou

    Chris is Head of Business Advisory​ at Archimedia Accounts and is a specialist in tax. For more advice book a FREE consultation:

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