Is it better to pay yourself a salary or Dividends?
Most Limited companies that we work with are owner-managed, meaning the day-to-day running is being done by the owner of the business. Where that is the case, as the owner and Director of the company you have a choice as to how you take money from your company. There are two primary choices:
- Take a regular, monthly salary from the business, the same way a regular employee would take a salary.
- Take a Dividend from the business.
Now the first thing to note is that Dividend’s are only possible where a company is profitable and has built up reserves which it can pay out to the owner. If that’s not the case, then you’re best-off speaking to your accountant to understand your options.
Assuming the business is profitable (or has been in the past) then both a salary and a dividend will be available to you as options – so which should you go for?
Well, it’s usually best to take a combination of both, typically a low monthly salary with the rest being paid out in Dividends.
Paying yourself as a Limited Company Director – why you should take a salary
As we’ll see below, when a Director pays themselves a low salary it usually results in an overall tax saving for both the company and the Director. This is because a salary paid to a Director is deductible for corporation tax purposes, and so assuming you set the salary at the right level it will actually reduce your tax bill.
But there is another crucial reason to pay yourself a salary, which is that assuming the salary is above £6,240 in 2021/22 then it will be a qualifying year for state pension purposes. This helps to ensure you qualify for a full state pension entitlement in the future. If you don’t pay a salary and just take dividends then there is a risk that you will not be accruing a qualifying year for state pension.
OK, so now you know why you need to take a salary, how do you do it? If you already have a payroll scheme setup (for example if you have other employees) then it will simply be a case of adding yourself to the payroll. Like an employee, you will be subject to PAYE, although if you set your salary at the optimum level discussed below then it’s likely no income tax will actually be deducted.
For those who do not already have a payroll scheme setup then you will need to register for PAYE and begin operating a payroll monthly. This is something your accountant (or we!) can help with.
Does a Director have to take a salary?
Where a Director is just an office holder and there is no contract of employment in place then the National Minimum Wage Regulations will not apply. This is the case for most owner managed businesses and so in short, no you don’t have to take a salary. But as we’ve already discussed above, taking a salary will reduce your tax bill and build your state pension entitlement so if you decide not to take a salary then you should have a very good reason for doing so.
For any Director’s who have a contract of employment in place then the National Minimum Wage Regulations are relevant and so it is a legal requirement to pay yourself a salary which is above this level.
What is the most tax efficient Director’s salary for 2021/22?
So, we now know that for most owner managed businesses it is better for the Director to take both a salary and dividends from the company, but what level should the salary be set at to be the most tax efficient option? Well, the exact answer will depend on your business’s specific circumstances, but we cover the two options below.
Option 1 – A salary equal to £8,840 per annum
This is appropriate for companies with no employees other than the Director.
A salary of £8,840 will result in a corporation tax deduction for the company of £1,680. It will not be subject to income tax as it is below the annual allowance of £12,570.
The reason a salary of £8,840 per annum is the best option for businesses with no other employees is due to the national insurance thresholds. We already know that a salary over £6,240 per annum is a qualifying year for state pension purposes, so we have met this requirement. The other relevant national insurance threshold is the secondary earnings limit, which in 2021/22 is £8,840. A salary about £8,840 will result in the company being subject to employers national insurance. This is an additional cost which will start to outweigh the benefit of the corporation tax saving, meaning the overall tax position worsens when the salary rises above £8,840.
So, for businesses with no other employees than the Director, the most tax efficient salary option will be £8,840.
Option 2 – A Salary equal to £12,570
This is appropriate for companies with other employees who are eligible for the £4,000 employers allowance.
A salary of £12,570 will result in a corporation tax deduction for the company of £2,388. It will not be subject to income tax as it is equal to the annual allowance of £12,570.
In this case, the salary is above both the national insurance secondary threshold of £8,840 and the primary threshold of £9,568 meaning employers national insurance and employees national insurance is payable. In this case, employers national insurance is payable on £3,730 at 13.8% resulting in a tax charge of £514.74. The employees national insurance is payable on £3,002 at 12% resulting in a tax charge of £360.24.
However, as the company is entitled to the employers allowance, the employers NIC is cancelled out. The increased corporation tax saving of £708 (compared to a salary of £8,840) outweighs the national insurance cost of £360.24 meaning its more tax efficient to pay yourself a salary of £12,570 in this case.
Summary – limited company Directors salary for 2021
So for most businesses, a salary of either £8,840 or £12,570 (depending on your specific circumstances) will be appropriate. Of course there are times where you should seek further advice. Some business owners may wish to pay higher salaries because the company cannot currently make a dividend payment, or because the owners will shortly be applying for mortgages, or perhaps they need to comply with the minimum wage regulations. So do consider your personal circumstances and tailor the salary as necessary. If you’d like to discuss this with our tax experts then we’d be happy to help – just get in touch.
Where the Director does take a low salary, then the remaining earnings should be paid out as Dividends, which are subject to a lower income tax rate and not subject to any national insurance.
For other ways a Director can reduce their tax bill check out:
