Which Is Better: Salary or Dividends?
Wondering what is the most tax-efficient way to take a salary from your company? If you run a business (even if you are a one-person operation) there are three ways to get paid for your business. They are Salary, dividends and Pension Contributions, today we give you all the need to know information to help you make the best choice when it comes to taking money out of your business.
How To Get Paid
A combination of salary and dividend is the usual approach that company directors take when drawing money from their business, often a pension contribution is taken also.
However, finding the right way to make money from your company will depend on company profit, how much personal tax you are comfortable with, how much corporation your company pays and whether you want to remain eligible for various state benefits.
Taking A Salary From My Company
The director should take a small salary, putting themselves on the business's payroll. The benefits of taking a small salary are:
Adding 'qualifying years' to the new state pension system (you will need at least 10 years to get a state pension).
Taking a higher salary allows you to make larger pension contributions, which in turn gives you more tax relief (until you hit £40,000 which is the tax relief cap).
A salary allows you to retain maternity benefits.
Taking a regular salary makes you more trustworthy from a bank's perspective, this will help you when it comes to applying for mortgages and insurance.
Being an allowable expense, any salary paid by your company to you and your employees is tax-deductible, which decreases your tax liabilities.
You can take a salary from your company even if you don't turn a profit.
There are a few cons when it comes to taking a salary from your business. The main one is that the higher salary you take, the more NIC contributions both you and the company will have to pay. A salary is also taxed at 20% once you cross the income tax threshold for that tax year.
Taking A Dividend From My Company
Salaries are the way 90% of people make their income. But as a company director, or shareholder you also have access to the wonderful world of dividend payments. Dividend payments are a much more tax-efficient way of paying yourself from your company. Most company owners take a large dividend payment as well as a small salary.
A dividend is a share of the company's profit. Once all the ins and outs of a business have been settled, all invoices raised, taxes paid and expenses claimed, you are left with profits. A portion of that profit can be taken as a dividend payment.
Dividend payments are taxed at lower rates than salaried wages. National insurance contributions are also not payable on dividends. Taking your income from your business in the form of dividends allows you to significantly reduce your tax bill.
On top of your standard income tax threshold, you get an additional £2000 (tax year 21-22) dividend tax threshold to go on top of your income. this lets you make up to £14,500 before you become eligible for income tax liabilities.
However, it's not all sunshine and rainbows, no profits mean no dividends. relying on Dividends as your main source of income can be risky if your business runs into a low or no profit period.
If you are planning on using dividends as the main source of your income we highly recommend talking with an accountant who is familiar with that kind of income setup. As it can be highly convoluted and very accurate records must be maintained to ensure you do not overdraw your dividend, which turns into a director loan which then has to be paid back to the company.
If you have found this information useful, why not try out some of our other articles written for business owners like you: