Starting a limited company is a groundbreaking moment for small business owners. This professional status does wonders for boosting your business credibility. Not only that - it also broadens the range of tax reliefs and benefits you might be entitled to. If you’re not sure whether you’re eligible to apply for limited company status (or if it’s worth it at the moment), check out our ‘Sole Trader vs Limited Company’ guide.
Being your own boss is an empowering - and sobering - experience. The success or failure of your business boils down to your decisions. One of the most important choices to make as a limited company director is what - and how - you’re going to pay yourself.
The most common way to do this is by combining a low salary and dividends, and withdrawing them from your limited company business account. It’s essential that you keep accurate, up-to-date records on any salaries and dividends. This information will help you comply with HMRC’s Self-Assessment filing standards, as well as keep track of your company’s overall financial health.
Note: The following information is applicable to limited companies. It works differently for sole traders. If you’re a sole trader, we haven’t forgotten you! You can read the guide we wrote especially for you right here.
Do I need to pay myself a salary?
You might wonder if it’s really necessary to pay yourself a fixed wage. After all, you own (or co-own) the business.
There are several benefits to taking a salary from your limited company. The most important plusses are as follows:
● Any official wages paid are tax-deductible. This means you can claim them as business expenses, reducing your annual profit. Lower profit equals lower taxes.
● You can automatically add qualifying years to your state pension - even if you’re self-employed - if your salary is above the Lower Earnings Limit (currently £6,240 in 2021-2022).
Less Corporate Tax, better pension...and all you have to do is get yourself paid. That’s pretty much the definition of win/win.
Why should I pay myself a lower salary?
You know your worth - and so do we. But when it comes to boosting your bottom line, sometimes it pays to play the long game.
UK taxpayers (including the self-employed) are entitled to a Personal Allowance. This means you won’t pay tax on the first £12,500 you earn (this number is increasing to £12,570 in 2021/2022). The National Minimum Wage will put most people over this annual threshold. However, according to HMRC, ‘office holders’ (people at a company without a contract) aren’t subject to minimum wage regulations.
You might be wondering how this is relevant. Simply put: if your salary is less than the £12,570 annual threshold, you won’t pay any Income Tax or National Insurance on your wages.
While this makes sense, you don’t want to go too low here. If your weekly wage is less than £120, for example, you’re not meeting the Lower Earnings Limit. Failing to hit this threshold means you’re no longer contributing to your state pension. Other important thresholds to be aware of are:
● The National Insurance (NI) Primary threshold (flying under this amount means you won’t have to pay employee NIC)
● The National Insurance (NI) Secondary threshold – (earning less than this amount means your limited company won’t have to pay any employer’s NICs
When calculating your director’s salary, try and find a happy medium that’s above the Lower Earnings Limit (so you qualify for state pension) and below the NI thresholds (so you won’t have to pay employee/employer National Insurance).
If you’re looking for a specific number to work with, a monthly salary at the National Insurance Secondary threshold for 2021/2022 is £736.66 (£8,840 per annum). This still keeps you above the Lower Earnings Limit, meaning you’re still contributing to your state pension.
When should I consider a higher salary?
While the advantages of a lower salary are listed above, there are also potential downsides. Keep in mind that low earnings on paper could affect the following:
● Loans and mortgage applications (although there are select mortgages that cater to the self-employed)
● Maternity benefits (you need to be employed to receive SMP - which would mean complying with the National Minimum Wage)
● Personal accident, critical illness, permanent health or other insurance policies (where the payout is based upon your earnings)
How does paying myself a salary affect my Corporate Taxes?
When paying yourself a wage, you’re technically classed as an employee of the company. This means your salary is subject to PAYE (Pay-as-you-earn) tax. This consists of three different types of tax: income tax, employee national insurance contributions, and employer national insurance contributions.
While paying yourself a higher wage allows you to claim more in expenses, it also hikes the tax you’ll pay in each of these brackets - meaning you might be better off with a lower wage.
Dividends are end-of-year profits paid to shareholders. Shareholders are owners of a company - which means you. If your business turns a profit (which it surely will in time), you can either:
a) Put those profits back into your company through reinvesting or
b) Pay yourself a shareholder dividend.
Dividends are another cost-effective way to boost your personal income. The tax paid on these is significantly lower than normal rates.
In summary, paying yourself a low salary and topping this up with dividends is a great way to reduce your overall tax liability. Having said that, there is a case for sticking with a higher wage, depending on your circumstances.
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