Deciding how you want to take an income from your company is a decision that requires a bit of planning on your part, and depends on what your personal circumstances are. In this post we'll discuss the different options available to you including either taking a salary or dividends as income, and the pros and cons of each option.
Most directors of limited companies pay themselves in some combination of salary or dividends, often supplemented by company pension contributions. Finding the right combination for you will depend on a number of factors, such as:
As a business owner or director, it's a good idea to take at least a small salary. This means putting yourself on your company's payroll. There are several benefits of taking part of your income as a salary.
There are however several drawbacks of taking a salary, particularly when it's a larger salary.
You don't pay income tax on your earnings until you pass the Personal Allowance (currently £12,570 in the 2023/24 tax year.)
However, you will have to pay NICs if your income passes the NIC Primary Threshold (also currently £12,570).
In addition, employer NICs become payable on any employee earnings above £9,100.
Note that in order to build up qualifying years for the state pension, your salary must be at or over the NIC Lower Earnings Limit (currently £6,396). Some directors therefore set their salaries between the Lower Earnings Limit and the Primary Threshold, so as to keep their state pension but avoid paying NICs.
Many directors choose to take the majority of their income in the form of dividends, as this is usually more tax-efficient.
A dividend is simply a share of the company's profits. Profit is what is left over after the company has settled all its liabilities, including taxes. If there is no profit, then no dividends can be paid.
Dividends can be paid to directors and other shareholders, according to the proportion of shares that they hold. There is no requirement to pay all the profits as dividends, or even any of them. A company can retain profits over a number of years and distribute them as the board decides.
You have a tax-free dividend allowance, which is in addition to your personal allowance. In the 2023/24 tax year this allowance is £1,000. This means that you can earn up to £13,570 before paying any income tax at all.
Dividends attract a much lower rate of income tax than salary does. There is also a slightly greater tax-free allowance when you are paid in dividends. You can see below for a comparison table.
Although taking your income mostly in the form of dividends may seem like a no-brainer, there are certain limitations and pitfalls to watch out for.
A third possible way to receive tax-efficient remuneration is in the form of pension contributions directly from your company. This is different from contributing to your pension yourself, as it counts as an employer pension contribution.
The last point above is an important one. As an individual, you are not allowed to pay more into a pension in a year than your salary for that year. Therefore, if you are taking a small salary plus dividends (as outlined above) then you can't pay very much into your pension.
However, employer pension contributions are not limited in this way. They are limited only by the annual allowance, which is currently £60,000 per tax year. Your company can contribute up to this amount into your pension, even if you are on a small salary.
Whilst retirement planning may not be a top priority in the midst of running a business, it is crucial to take proactive steps towards securing your own financial future. Pensions are a tax efficient way to extract wealth from your business, and this helps ensure that your own financial plan is diversified. Consulting a financial planner can be instrumental in securing financial stability for yourself and your business. We can help you to consider how much you can save into a pension.
If you're interested in learning more about our services and would like to schedule an initial meeting, feel free to reach out to us at 0191 384 1008 or email us at enquiries@wealthofadvice.co.uk.
