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Dividends vs salary: What’s better for company directors?

Dividends vs salary: What’s better for company directors?

If you have a limited company there are various ways you can extract your profit depending on your different roles within the business.

Taking a salary

Salary can be paid to you as a director. If you have an employment contract you will need to comply with National Minimum Wage requirements, so most director-shareholders do not have one. This also has implications in the event of redundancy etc.

There is a salary at which the director pays 0% national insurance, but still qualifies for pension, sickness and other benefits. This is £8,788 pa 2020/21. If the company has unused Employers Allowance due to additional employees then it may be more beneficial to pay a salary to the director of the annual personal allowance of £12,500 pa 2020/21.*

Keeping track of a director’s wages and dividends is not always easy. Our Starling business account comes with transaction categories specifically for these, so they are easy for a customer to track.

Paying yourself in dividends

Dividends are a share of the profits which are paid to business shareholders as a return on their investment. Unlike paying salaries the business must be making a profit (after tax) in order to pay dividends. Because there is no national insurance on investment income it’s usually a more tax efficient way to extract money from your business, rather than taking a salary.

There’s a tax free dividend allowance for the first £2,000 pa, after which the tax rate on company dividends is 7.5% or 32.5% (2020/21) depending on your other income. Only shareholders can receive dividends as a reward for their investment risk. Directors who are not shareholders can not receive dividends.

Other ways to extract profit

  • Interest can be paid to you on money loaned to the company. Interest is not subject to national insurance. There are rules and reporting requirements around this so it is best to talk to your accountant.
  • Rental of home office can be claimed at £6 per week with no additional paperwork or tax requirements. Or the landlord/director may grant a licence to the company. In the company accounts paying rent to the director in this way will save the company tax at 19% (2020/21).
  • On the director’s side this rental income (less costs) is taxable via the director’s personal tax return. To save paying personal tax, it’s usual to set the rent at the same level as the costs so there is no additional tax to pay.
  • Pensions can also be paid into a pension scheme for the director. The company can claim the pensions paid as a business expense and the director has no tax to pay until they draw down the pension in retirement. This may be very tax efficient but obviously the director cannot access the money immediately.

How you take out your profit may have an impact when applying for a mortgage so it’s worth using an adviser who understands owner-managed businesses.

However you organise your business, good accounting is essential. Our Business Toolkit comes with all kinds of easy to use accounting and bookkeeping features.

If you have multiple shareholder-directors, the principles of how you extract money should be written into a shareholder’s agreement and/or a director’s service contract so that everybody is clear.

*This information is not intended as tax advice for which you should seek the help of a competent accountant. All rates are correct at the time of publication.