One of the main benefits of working via a limited company is that you can take advantage of tax planning measures not available via other business structures (such as umbrella companies).
This article has been updated for the 2020/21 tax year.
The main benefit of drawing down dividends from your company is that they are not subject to National Insurance deductions, unlike salaried income.
As a company director, as you are in control of your own finances; you can decide when to declare company dividends – you may want to postpone taking a certain amount of dividends until a future tax year, for example.
For a number of reasons we will explore below, most limited company professionals pay themselves a small salary and distribute the rest of their company profits as dividends.
Optimum salary for company directors in 2020/21 – key considerations
When deciding on the level of salary you pay yourself in the current tax year, you need to consider various factors, particularly the current income tax (personal allowance) and National Insurance thresholds.
- Take into account any salary already earned from a previous job (if applicable), when working out how much further salary you wish to draw down in the current tax year.
- The current tax-free personal allowance is £12,500, so if your salary is less than this amount, you will have no PAYE income tax to pay at all.
- The value of the personal allowance is gradually withdrawn by £1 for every £2 you earn above £100,000 each tax year. This means that your entire personal allowance will have been removed by the time you hit the £125,000 mark.
- Your company pays 13.8% Employers’ NICs on salaries above the Secondary Threshold of £169/week (£8,788/year).
- The ‘Employment Allowance’ allows eligible businesses to reclaim up to £4,000 in Employers’ NICs. However, company directors who receive small salaries will not benefit unless they earn £8,788 or more. You cannot claim the EA if you are a sole director, with no other employees.
- As a company employee, you pay 12% Employees’ NICs on salaried income over the Primary Threshold £183/week (£9,500/year). You can check the latest NIC rates and thresholds here.
- Check with The Pension Service to see if your state pension will be affected by the level of NICs you pay, as if you pay yourself too low a salary, you may affect your pension entitlement. You can access a personal pension statement if you register online via the Government Gateway.
- If you have a contract of employment with your company (however unlikely this may be), then you must pay yourself the National Minimum Wage @ £8.72 per hour for adults aged 25 or above.
- You should also check with your accountant if there is a minimum salary required if you make contributions to a personal or executive pension scheme.
This article assumes that your contract work is not subject to the IR35 rules. Any income caught by IR35 must be taxed in the form of a deemed salary, rather than dividends.
What is a tax-efficient directors’ salary in 2020/21?
As well as looking at the new NIC thresholds, the optimum salary paid to directors depends on whether your company can claim the Employment Allowance (EA) or not. This incentive refunds the NIC bills of eligible businesses to encourage them to take on staff.
The rules changed in April 2016, so if you’re the sole director of a company (with no other employees), you cannot claim it. There are several other restrictions that limit the eligibility of many small companies.
For the 2020/21 tax year, if you pay yourself an £8,788 salary, you will pay no income tax or National Insurance at all. This number is the Secondary Threshold, below which no Employers’ NICs are payable.
£8,788 is a tax-efficient salary if you cannot claim the EA. No NIC or Income Tax payable.
Unlike the previous tax year, the rates of Employees’ and Employers’ NICs are different in 20/21. Whereas you start paying Employers’ NICs when annual salary > £8,788, Employees’ NICs do not become payable unless annual salary = £9,500 (the Primary Threshold).
So, if you pay yourself £9,500, you still pay no Employees’ NICs or Income Tax. However, there will be a small amount of Employers’ NICs to pay (approx. £56 per year) if your company can’t claim the EA.
Clearly, this is marginally more tax-efficient than £8,788, but this will involve some administration – to deal with the NI side of things. This may well be carried out by your accountant at no extra cost, but it’s worth finding out.
£9,500 is the most tax-efficient salary level if you cannot claim the EA. Some minor admin is required to deal with Employers’ NIC.
If you can claim the EA, and pay yourself a salary of £12,500, there is no income tax to pay (as this is the same amount as the personal allowance).
Ordinarily, you would also have to pay Employees’ and Employers’ NICs of £360 and £512.26 respectively.
However, the Employers’ NIC element is cancelled out by the Employment Allowance, so your only liability is £360 in employees’ NICs.
Also, by taking a £12,500 salary, you save £705.28 in additional Corporation Tax you’d have to pay if you take an £8,788 salary.
So, £12,500 is the most tax-efficient salary to take for the 2020/21 tax year if you can claim the EA (you’re better off by £345), although there is a little more admin involved.
Salary / Dividend Tax Calculator
Use this embedded Excel spreadsheet to work out your salary and dividend tax levels for 2020/21.
The calculations in this article have been validated by our accountant. We recommend that you seek professional advice from your own accountant before setting your company’s salary levels.
When working out dividend amounts, you must ensure that you have sufficient retained profit in your company, otherwise your dividend declaration could be classed as ‘illegal’.
You should discuss your overall remuneration strategy with your accountant before relying on any information contained within this article; after all, this is the most important aspect of the service they should provide you.