Starting a limited company is a ground-breaking 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.
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.
TOP TIP: This advice is specifically for limited companies. If you’re a sole trader, head on over to this handy guide. If you’re not sure whether you’re eligible to apply for limited company status (or if it’s worth it yet), check out our ‘Sole Trader vs Limited Company’ guide.
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 biggest positives are:
- 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 £6,396 per year in 2022/2023).
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 £12,570 you earn (2022/2023).
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).
TOP TIP: If you’re looking for a specific number to work with, check out the new rates and thresholds for 2022/2023 on the gov.uk website.
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 pay-out is based upon your earnings)
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.
Can I Pay Myself Through Dividends?
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:
- Put those profits back into your company through reinvesting or
- 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.
WANT SOME HELP WITH THAT?
It’s all about you, as far as we at Addition are concerned. You and your business are one and the same (even if it’s not on paper) – meaning looking after you and looking after your finances go hand in hand.
If you’d like our support in deciding the best route for you, why not give us a call? We can make it all add up together!