Finding the Sweet Spot: The Ideal Director’s Salary

Finding the Sweet Spot: The Ideal Director’s Salary

 

In a previous post, we looked at the different ways you can extract income from your limited company: by paying yourself dividends from the company’s profits, or by taking a salary as a company director. (Spoiler: we concluded that a mix of the two is the best way to make the most of your company’s earning potential. You can read the full post here.) 

If a director’s salary is in your sights, you might be wondering how much that salary should ideally be. Let’s look at the different factors that affect this calculation.

The tax-free allowance

In theory, a director’s salary can be as little or as much as you want to pay yourself. There’s no minimum wage requirement and no cap on earnings. However, there are tax and National Insurance factors that you should consider, starting with the tax-free annual personal allowance. In 2021/22, this is £12,570 per year.

If you already have other income that exceeds that amount, your salary will be taxable as normal on a PAYE basis. But if you don’t, then part or all of your director’s salary can be free of income tax. So this is one number that should be part of your calculations.

National Insurance 

A salary is a great asset because it’s stable and predictable. You don’t have to wait to be in profit before you can extract income from your business, as you do with dividends. And, once you cross a certain threshold, you’ll also accrue National Insurance (NI) contributions towards your state pension and benefits. 

The current threshold (Lower Earning Limit) to qualify for NI is £6,396 per year. If you earn under this amount, you won’t pay any NI and you also won’t accrue any contributions. If you earn above £9,880 (the Primary Threshold), you will start paying 12% NI on your earnings. 

The killer here is the Secondary Threshold, which is set a little below the Primary Threshold at £9,100. At this point, both employer and employee become liable to pay NI contributions. If you’re not careful, you can end up paying two sets of contributions on the same salary: as company owner (employer) and company director (employee).

However, if your salary sits in that sweet spot between the Lower Earning Limit and Secondary Threshold, you’ll have the best of both worlds. You won’t pay any NI, but you will accrue credits that will count towards your record of contributions. Ideally, then, your maximum salary as a company director is £9,100 per year.

One director or two?

If your company has two or more directors, the Employment Allowance means that you – in your role as company owner – can claim an annual reduction of up to £4,000 on the National Insurance you pay for your employees. This effectively eliminates the double-contribution problem and raises the limit of your ideal salary to the Primary Threshold: £9,800.

Setting the right director’s salary is just one way to make the most of your limited company. Our friendly, affordable online accounting service can help you navigate self-employment with ease. Just get in touch for a free, personalised quotation.