For most limited company directors, the optimal solution is to pay a low salary and then to pay dividends.
Why is this the case?
- If you pay yourself a salary no higher than the personal allowance, there is no personal tax to pay on it
- You should however ensure that the salary is high enough for national insurance purposes to count as a “qualifying year” – towards your state pension and other benefits
- Then pay additional amounts as dividends – as there is no national insurance payable on dividends. Ideally keep total income under £50,270 to avoid paying higher rate tax
- The salary paid is an expense of the business and therefore reduces your profit, and your corporation tax
Obviously, every person has a different personal tax situation and this is only intended to be general guidance for salary levels. We have assumed:
- You are a UK resident
- You have no student loan
- You have no other income other than salary and dividends from your company
- You are not working inside of IR35
- You have a standard personal allowance
- Your company has sufficient post tax profits to legally pay these dividends
So what salary should you pay yourself this year?
First we need to understand the impact that National Insurance has on your salary choice, as you start paying NI at a lower level of income than you start paying income tax.
There are 3 NI thresholds to consider:
- Lower Earnings Limit – If your salary is above this limit, you’ll keep your future entitlement to state pension and benefits. However, you don’t actually pay any NI contributions. For the 2021/22 tax year the threshold is £520 per month or £6,240 per annum
- Primary Threshold– Once you earnings start exceeding this threshold you will pay employee’s national insurance. The limits are £797 per month or £9,568 per annum for the 2021/22 tax year
- Secondary Threshold– When you earn above this threshold, your company is required to pay employer’s national insurance. The threshold for 2021/22 is £736 per month or £8,840 per annum.
Salary Option 1:
The first strategy is to pay yourself a salary up to the Employer’s National Insurance Threshold – £736 a month or £8,840 per annum. This is the most that you can pay yourself without you or your company paying any income tax or national insurance on your salary.
You can then pay dividends of £41,430 without paying any higher rate tax, and your basic rate tax bill for the year would be £2,678.
The company would save corporation tax of £1680 (19% x £8,840)
Salary Option 2:
The second strategy is to pay yourself a salary up to the Personal Allowance threshold of £12,570 or £1,047.50 per month.
This level of income is above the NIC thresholds, so you will pay employees NIC of £360 on your salary over the course of the year, resulting in net pay of £12,210.
Technically the company will also pay employers NIC, but if you have more than one employee earning over the LEL, then you can claim the NIC employment allowance. This is currently up to £4,000, and is offset against the employers NIC due, resulting in none actually being paid!
Note that a sole director cannot claim this allowance, so the company would then pay £514 in employers NIC on this salary.
If you pay a salary of £12,570, you can then pay dividends of up to £37,700 without paying higher rate tax. Your personal income tax bill would be £3,038 and the company would save £2,388 in corporation tax.
Option 1 or 2?
If you have more than one employee and can benefit from the employers NIC employment allowance, then taking the corporation tax and personal tax into account, you would be better off by £348 going with Option 2.
Option 1 would be better for a sole director.
For both these options, the company needs to have a proper payroll set up and be reporting monthly to HMRC under RTI. If you want to pay any salary at all from your company then you need to speak to an accountant to ensure this is being done properly as there are penalties for getting it wrong!
If you would like more information or help in respect of your personal position then please get in touch.