Salary vs Dividends? A Guide for Company Directors

If you’re preparing to set up your own limited company, at some point you’ll be asking yourself the following questions. Should I pay myself a director’s salary, or are dividends a better choice? Or should I combine the two?

It’s an important thing to think about, because the path you choose can potentially affect your income and how much tax you will pay. In this post, we’ll take a look at the differences between salary and dividends, and some of the pros and cons of each. 

Salary

If you’re a director of a limited company, you can choose to pay yourself a salary. This salary isn’t subject to the national minimum wage requirement, so in theory, your salary can be as low or as high as you prefer. However, there are a couple of useful thresholds to bear in mind.

The first is the annual personal allowance, which for 2021/22 – and beyond – is £12,570 per year in England and Northern Ireland. This is the amount you can earn per year before you start paying income tax.

The second set of thresholds relates to National Insurance. In 2021/22, if you earn under £6,396, you won’t pay National Insurance but also won’t accrue credit towards your state pension or other benefits. However, if your income is over £6,396 and under £9,880, you still won’t pay National Insurance on that amount. But you will be given all the same benefits as someone who is paying. Depending on how much of your income you need to get from your business, this might be considered the “sweet spot” for a director’s salary.

Dividends

If you want to extract profit from your business without paying yourself a salary, dividends can be very useful – especially since they’re not subject to National Insurance.

If you’re already earning more than the annual personal allowance, you will have an additional tax-free allowance of £2,000, especially for dividends. However, the subsequent tax rate can be lower (7.5%) or higher (32.5%) depending on your other earnings.

If you do opt to pay yourself dividends, it’s not an easy process. First of all, the dividends paid out to you and/or other shareholders must come from the company’s profits. This means you have to wait until your company is turning a profit before you can calculate how much you can extract. You will then need to hold a directors’ meeting for every payment – even if you are the only one – keep strict minutes, and produce a correctly formulated dividend voucher.

Which should I choose?

By now, it should be evident that both salary and dividends have certain advantages and disadvantages. The good news is that you don’t have to choose one or the other. Many people decide to pay themselves a base salary and top it up with dividends in order to get the best from both options.

Ultimately, the best choice for you will depend on your own circumstances. If you’d like to talk over your options as a limited company director or make use of our bespoke tax return service, just get in touch for a personalised quotation.