As a new company director in the UK, you are likely wondering how to best pay yourself through your company. You have several options for transferring company profits into personal income, including salaries, dividends, and investments. This post outlines the pros and cons of each, and gives you the information you will need to make your income as tax efficient as possible.
How can a company director pay themselves?
Company directors are considered employees of the company and so take a salary which is subject to income tax. Directors can also pay themselves using dividends, which are a common method of distributing profits to shareholders (which includes directors).
Salaries and dividends are subject to different tax rates, tax-free allowances, and National Insurance obligations, which we break down below.
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What is the difference between salary and dividends?
Dividends are a way for companies to distribute a portion of their profits to their shareholders. As a director, you can choose to pay yourself through dividends instead of a salary. Dividends are typically paid out after the company has paid its taxes and can be a tax-efficient way to receive income.
However, there are some basic rules to follow. Firstly, your company must have sufficient profits to pay dividends, and you should keep records of these profits. Secondly, dividends must be declared and approved by the company’s shareholders. Lastly, dividends cannot be paid if the company is insolvent or if the payment would render it insolvent.
When it comes to tax purposes, it’s important to find the right balance. Dividends are subject to lower tax rates than salaries. You also do not need to pay National Insurance Contributions on dividend income, which you would have to do so on any salary income.
Lastly, as is also the case with personal income tax, a certain amount of dividends you receive is tax-free.
You can read our full guide to dividends to learn more.
What is the most efficient way for a company director to pay themselves?
From the explanation above, it should be clear that paying yourself efficiently as a company director involves balancing tax-free personal allowances and differing tax obligations.
The table below should be very helpful in outlining these differences between salary and dividends.
At the most basic level, directors clearly want to use all of their available tax-free personal allowance. That means taking at least £12,570 as salary and £1,000 as dividends.
It is important to note that once you reach the Higher Rate income bracket, your personal allowance amount begins to decrease. And in the Additional Rate bracket, there is zero tax-free personal allowance.
An important factor that is left out of the above table is the added cost of National Insurance Contributions on salary income. National Insurance Contributions must be paid both by the employee and employer. The basic NIC rate for employees is currently 12% of earnings, and an additional 13.8% of earnings to be paid by the employer. These are basic figures, see our guide to National Insurance for a detailed understanding.
As a company director, you will effectively bear both of these costs, making salary income even less appealing when compared to dividends. A common strategy is to take enough of a salary that the director qualifies for state benefits such as the State Pension, but that does not incur NIC payments.
Under most circumstances, dividends will be more tax efficient than salary income, though how easy it is to distribute dividends will depend on the structure of your company and its shareholders.
Using investments as tax-efficient income sources
It is also important to take advantage of any other tax free allowances that HMRC makes available. An example of this would be transferring company profits into investments, rather than personal salary. In that way, you could take advantage of the tax-free capital gains allowance of £6,000.
Trusts are another way of accomplishing this, and which have their own tax-free capital gains allowance of £3,000.
It is also essential to consider how increased income may push you into a new tax band, and create much higher tax liability. For example, the dividend tax rate jumps from 8.75% in the first income bracket to 33,75% in the second.
As such, it may be more profitable in the long term to reinvest money into business (tax-free), or into other investments, rather than taking extra personal income that pushes you into a higher tax band.
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