Unlike sole traders, a director can decide how much and by what means they extract the profit from their business, providing greater control on how they are taxed personally.
Consequently, directors must decide how to pay themselves through a combination of salary and dividends. The most tax efficient way to achieve this will depend on their specific circumstances and is relevant to the number of directors and employees the organisation has.
This guide covers the key areas of concern when deciding how to balance salary and dividends for maximum benefit…
Salary
Company with 1 director or employee
A director should consider taking a salary of £12,570 per year (£1,047.50 per month).
They will incur National Insurance (NI) on their wages above this threshold.
However, claiming tax relief on allowable expenses (such as salary will lower the Corporation Tax a limited company must pay. In fact, this reduction will be more than the employer’s NI their company must pay, therefore cancelling the NI payment out.
A director may choose to take a lower salary of £9,100 (£758.33 a month) so there’s more money left for dividends at the end of the year, or if they want to avoid the complication of paying NI to HMRC each month.
Company with more than 1 director or employee
Directors in this situation should consider taking a salary of £12,570 per year (£1,047.50 per month), as this is the threshold for paying both Income Tax and employees’ NI.
In addition to this, if their company has at least 1 employee or 2 directors on its payroll, they will be eligible for the National Insurance Employment Allowance (as long as the directors are not already claiming this allowance for another company).
In 2024/25 eligible employers can claim up to £5,000 to fully cover the costs of employer’s NI.
For more information on the latest tax rates and allowance, read our guide…
Dividends
To pay dividends, you need to have distributable profits. This may seem obvious, but it’s an important point to remember. You need to not only consider the profits in the current year, but you must also review accumulated profits, since dividends cannot be paid out of losses.
It’s relevant to note that profits aren’t the same as cash in the bank. Your company could have cash in the bank, but if there are no profits, dividends should not be paid.
Dividends are not subject to NI (and consequently do not count towards your State Pension), but are subject to tax at a different rate to normal Income Tax.
There is a separate dividend tax allowance that you can use on top of the Personal Allowance. For 2024/25, the tax-free dividend allowance has been reduced to £500. Dividend amounts within this band are tax free, as are any dividends covered by the remaining unused Personal Allowance.
How much tax you pay on dividends above the dividend allowance depends on your Income Tax band.
Basic rate – 8.75%
Higher rate – 33.75% – Total income exceeds £50,270
Additional rate – 39.35% – Total income exceeds £125,140
Note: The £500 allowance is treated as using up part of the basic rate tax band, not in addition to the basic rate band.
Other considerations
You may need to consider other factors, such as:
- You may have insurance policies that pay out based on a multiple of your salary. If you opt to pay yourself dividends instead of salary, it may reduce any pay outs if claims are made.
- There may be other methods of remuneration as part of the overall package, such as a pension or providing a company car.
- Think about the timing of dividends to minimise the tax impact.
- To get a full state pension you currently need 35 years on your NI Record and a minimum of 10 years to receive anything at all.
Need some guidance?
If you require further guidance on any of the topics covered in this article, please get in touch with us and a member of our team will be happy to assist you.
