Running your own company means you have more flexibility regarding when and how you choose to pay yourself. You have the freedom to structure your own compensation to make it more tax-efficient by subsidising your director’s salary with shareholder dividends.
How much you should pay yourself as a business owner depends on your situation. You’ll ultimately want to strike a balance between investing in your company and paying yourself a wage.
In this guide, we’ll take a look at:
- Dividends vs salary: how should I pay myself?
- Benefits and drawback of salary vs dividends
- How much dividend can I pay myself tax-free?
- Finding the perfect balance between dividends and salary
Read on to learn more about salary vs dividends so you can find the most tax-efficient combination for your business.
Dividends vs salary: how should I pay myself?
As a director, it’s a good idea to take at least a small salary, meaning you put yourself on your company’s payroll as well as potentially qualifying for State Pension credits. However, like any employee, you’ll have to pay Income Tax and National Insurance Contributions (NIC) if you earn above any allowances. We’ll explain more about how these taxes work in a later section.
Benefits of taking a salary
- If you earn above the NIC Lower Earnings Limit (explained below), you build up qualifying years towards your state pension.
- Paying salary is an allowable business expense, meaning your company can account for this cost as an allowable expense and reduce the Corporation Tax liability.
Drawbacks of taking a salary
- Taking a salary above the Primary Threshold means both you and your company have to pay National Insurance contributions (NICs).
- Paying yourself completely via salary and not including any dividends may mean you attract a higher rate of income tax.
A dividend is simply a share of the company’s retained profits (the funds you have left after paying your expenses), which you distribute to directors and other shareholders, according to the proportion of shares they hold.
Just like with salary, paying yourself in dividends has its own benefits and drawbacks as listed below:
Benefits of paying yourself in dividends
- Dividends attract lower rates of Income Tax than salary, which we’ll explain in the next section.
- You don’t have to pay any National Insurance Contribution (NIC) on dividends.
Drawbacks of dividends
- Dividends can only be paid out of retained profits, which makes it an unpredictable income that is dependent on the company’s post-tax profits.
- If you accidentally extract a dividend that your retained profits cannot cover, you’ll have (accidentally) taken out a director’s loan –– which must be repaid to the company within a set timeframe to avoid any adverse tax implications.
- Dividends don’t count as ‘relevant UK earnings’ for tax relief on pension contributions.
How do I get taxed on a salary vs dividends?
Company directors paying themselves a salary are taxed through the HMRC Pay As You Earn (PAYE) system. Like any employee, you will pay Income Tax and National Insurance Contributions (NIC), along with additional employer’s NIC, depending on the level of salary received.
However, salaries count as a deductible business expense that can reduce the business’ trading profits, meaning your company is reducing its Corporation Tax bill. Your company will only be charged Corporation Tax at 19% on the trading profits.
Income Tax rates
The threshold for Personal Allowance is an annual wage of £12,570, which you don’t get taxed on. Wages above that threshold are taxed at the following rates:
- 20% (Basic rate) – £12,571 to £50,270
- 40% (Higher rate) – £50,271 to £150,000
- 45% (Additional rate) – Over £150,000
National Insurance Contributions rates
You and your employees must also make Class 1 National Insurance Contributions on earnings above a certain level.
On income between the Primary Threshold (£797/month) and Upper Earnings Limit (£4,189/month), you pay 12% as an employee’s NIC.
Those that earn more than the Upper Earnings Limit pay a reduced rate of 2% NIC above this point.
Your company will also have to make employer’s NIC at a standard rate of 13.8% on your salaried income above £737/month (the Secondary Threshold).
Visit HMRC for more details about NIC rates and thresholds.
How much can I pay myself in dividends tax-free?
When paying yourself in dividends, you only have to pay Income Tax on any payments exceeding the Dividend Allowance of £2,000 per year. The tax rate you have to pay depends on your overall income tax bracket.
However, dividends have lower tax rates than salaries do:
- £12,571 to £50,270 (Basic rate) – 7.5%
- £50,271 to £150,000 (Higher rate) – 32.5%
- Over £150,000 (Additional rate) – 38.1%
You can find more details about Dividend Allowance and Tax Rates at HMRC.
Finding the perfect balance between salary and dividends
Paying yourself a salary has many benefits and can be a cost-effective way to draw money from your company. Although, as you pass the National Insurance threshold, taking a salary becomes less and less tax-efficient.
You might choose to pay yourself a higher salary to access maternity benefits, which are only available to those who make more than the National Minimum Wages. Paying yourself a wage above the NIC Lower Earnings Limit also contributes to your state pension.
Ultimately, how you choose to balance your income between a director’s salary and dividends depends on how much your business makes and what Income Tax bracket you fall into.
Some business owners find that paying themselves a salary up to the tax-free allowance and subsidising the rest via dividends is the most tax-efficient way. Just make sure you understand the rules surrounding salary and dividends before making any moves.
How Countingup can help you stay on top of your taxes
Bookkeeping and tax admin can be stressful when running your own business.
That’s why Countingup has combined a business current account and accounting software in one app. The system automates the time-consuming aspects of your financial admin so that you can focus on growing your company.
Find out more here.