If you are a director and shareholder of a limited company, choosing between a salary and dividend is a common dilemma when looking at remuneration planning. There are further considerations following the Spring 2024 budget with the reduction in Class 1 National Insurance contributions.
As a director you are legally separate from your limited company, and this means that you are not allowed to simply keep the profits in the same way that a sole trader can. Instead, you will need to decide how much to pay yourself and the choice between drawing a salary or receiving dividends can have significant implications for your personal finances, tax obligations and the financial health of your company.
Put simply, dividends are a share of the company profits that are distributed to shareholders of the company. A salary on the other hand is what you pay yourself as an employee of your own company and below we look further into the considerations of taking a salary or dividend.
Taking a salary from your company
As a director, it is often a good idea to take at least a small salary and there are several advantages and considerations when deciding on what level of salary to pay yourself from the company:
- You build up qualifying years towards your state pension if you earn above the lower earnings limit (the annual lower earnings limit is £6,396 in 2024/25)
- Your salary is an allowable business expense and therefore your salary reduces the company corporation tax liability
- You can take a salary even if your company makes no profit
- Your salary will be subject to income tax if the level of your salary is above your tax-free allowances
- Depending on the level of your salary, employer and employee National Insurance Contributions may be due
- The employment allowance allows eligible employers to reduce their annual National Insurance liability by up to £5,000 each tax year. If you are a director and the only employee of the company, the company will not be able to claim this allowance
Taking dividends as income
Dividends can be paid to shareholders of the company according to the proportion of the shares that are owned and there are several factors which may impact your decision as below:
- Dividends attract lower rates of income tax than a salary
- No National Insurance contributions are payable on dividends
- Dividends offer flexibility in distribution, allowing you to choose when and how much to distribute
- The tax-free dividend allowance for 2024/25 is £500
- Dividends can only be paid out of profits meaning if there is no profit, no dividend can be paid
- Dividends are paid after corporation tax has been deducted (unlike salary, which is a tax deductible expense)
Traditionally, there has been a relatively straightforward option known as the low salary and high dividend strategy where a company owner would be paid an annual salary of between £6,396 and £12,570 and then top this up with dividends. A salary of this level will ensure you gain a qualifying year towards your state pension and the salary is an allowable expense for corporation tax. In addition, and assuming your annual taxable income does not exceed £100,000, your salary would be covered by your personal allowance. Any dividends paid over and above your tax-free allowances would be subject to tax at 8.75%, 33.75% or 39.35% in 2024/25, which will depend on your marginal rate.
However, the tax landscape is constantly changing, and the low salary and high dividend strategy may not be the most tax efficient remuneration strategy for everyone following changes over the last year. On 1 April 2023, corporation tax rates increased from 19% and will range from 19% to 25%, with the rate of corporation tax dependant on your company profits. In addition, Class 1 National Insurance contributions were cut 2 percentage points from 12% to 10% from 6 January 2024. In the Spring 2024 budget, Class 1 National Insurance contributions were cut by a further 2 percentage points to 8%, with these rates effective from 6 April 2024.
The low salary and high dividend strategy is no longer guaranteed to be the most tax-efficient strategy overall, meaning it is even more important to find the right solution for you. A mixture of salary and dividends is likely to be the right solution but finding the right balance will depend on your individual circumstances, tax planning and financial goals.
