As a director, deciding how to pay yourself can be a complex subject, especially since the changes to corporation tax came into effect on 1 April 2023. So long as you’re a shareholder, two common options that are available to directors to pay themselves are salary and dividends.
To help navigate the maze of associated costs and weigh in the pros and cons of both, Stephen Tucker, Director of our Leeds office, is here to guide us through.
Take it away Stephen…
Over the years, I’ve helped numerous directors understand the intricacies of managing their finances effectively, and choosing how to pay yourself, although sounds easy, can be a minefield!
So you can make an executive decision on what works best for your business, below I’ve outlined everything you need to know when paying yourself as a director. Let’s start with the basics.
Understanding salary and dividends
Put in simple terms, dividends are a share of the company’s profits that you distribute to yourself as a director. A salary on the other hand is what you pay yourself as an employee of your own company. Sounds simple enough right? But it does get more complicated when deciding either salary or dividends to pay a director. Let’s go back to dividends…
Are dividends your friends?
Again, dividends are payments made to shareholders that are based on the company’s profits. As a director, if you own shares in the company, you can choose to pay yourself through dividends. The business must be making a profit after tax to pay dividends.
This method offers several advantages – dividends are typically taxed at a lower rate than salary income. Furthermore, dividends allow for flexibility in terms of timing, as they enable you to adjust your income as per your current financial needs. However, the recent cuts to dividend allowances means that a bigger amount of dividend income may be subject to higher tax rates, which reduces the overall tax advantages.
Only shareholders can receive dividends as a reward for their investment risk-directors who aren’t shareholders can’t receive dividends.
It’s important to note that dividend payments must be based on the company’s profits and comply with legal requirements.
Paying yourself a salary – stability and benefits
They may not have the same tax advantages as dividends, but a salary does offer stability and benefits. You can set a fixed income, contribute to pension schemes, and enjoy other employee perks. If you’re a director, this means that you’re technically an employee of your own limited company. As both employers and employees pay National Insurance Contributions (NICs) on salary payments, if you opt to pay yourself a salary, this means you would make contributions to NI, but wouldn’t on dividends.
Plus, if you’re looking to show a consistent income for things like loans or mortgages, a salary is your ticket to success.
A disadvantage of taking out a director’s salary is the higher taxation. A director’s salary is subject to income tax. This includes personal allowance and higher rate thresholds. With the changes that came into effect to reduced income tax additional rate thresholds, it could mean higher tax liabilities for many directors.
What should I choose? Factors to consider
Choosing whether to pay yourself in dividends or salary depends on a variety of factors. Here are some key considerations to keep in mind when deciding whether to pay yourself in dividends or a salary:
Tax Efficiency
Think about the tax implications and potential savings associated with each payment method – crunch those numbers and see which option can give you more bang for your buck.
Financial Stability
It’s important you have a clear idea of your personal financial goals, commitments, and the need for a consistent income stream – if you need more financial security choosing a salary can help to provide more consistency.
Legal Compliance
Ensure that the company’s profits allow for dividend payments and that you fulfil all legal obligations.
Retirement Planning
Evaluate how each option aligns with your long-term retirement plans – it’s never too late to think about your golden years!
Personal Circumstances
Assess your personal circumstances, such as other income sources or eligibility for state benefits.
So, what’s the verdict?
It’s crucial that personal financial circumstances are evaluated and assessed, and tax changes are considered before deciding between a director’s salary or dividends. Whilst dividends can offer flexibility and are more tax efficient, they aren’t subject to NICs, which could mean reduced allowances.
A salary however, provides advantages like pension contributions but comes with higher taxation and therefore impacts tax liability.
Understanding the associated costs and benefits of paying yourself as a director is crucial for financial success. By weighing the advantages of dividends and salaries, considering key factors, and seeking professional assistance, you can ensure that your payment method aligns with your goals and maximises your financial well-being.
