Earning a Salary Vs Taking a Dividend - Which is Best?

If you are the owner of a limited company, there can be numerous ways in which you can extract the profits of the business to pay yourself. Two key ways are simply paying yourself a monthly salary, or you could pay yourself in dividends. There is also the possibility of blending the two and paying yourself a dividend each year on top of your monthly salary.

Paying Yourself a Salary

Let’s say your job title is ‘Director’ of the business. As a director, you can receive a salary. If you have an employment contract with the business, you are required to comply with any National Minimum Wage requirements. However, most ‘Directors’ who are also the owner or shareholder of the business do not have an employment contract. So, there are some complications there.

As of 2020/21, if you were to pay yourself only £8,788 per year, you, as director, would pay 0% national insurance but still qualify for pension, sickness and other benefits. Further to this, if the company has unused Employers Allowance due to having any additional employees, then it can be better to pay a salary to yourself as director to a level of £12,500 per year which is the annual personal allowance level (as of 2020/21)

It is clear here that it can be complicated to get the maximum benefit from paying yourself a salary as a business owner. You would need to stay on top of the annual changes in regulation and benefit limits, and may need to change the amount you pay yourself on an annual basis, or as specifics within your business change (IE - additional employees)

Paying Yourself a Dividend

Dividends in their simplest form are a share of the profits which are paid to the shareholders of the business as a return on their investment in the business. One requirement for a dividend to be paid is the business must be making a profit after tax in order to be able to pay a dividend. Technically, a dividend can also be paid out of the company reserves, if there are any.

There is no national insurance on investment income (which dividends are classed as), and therefore paying yourself a dividend rather than a salary can be a more tax efficient method of obtaining money from your business.

You can receive dividends of up to £2,000 per year tax free (as of 2020/21 & 2021/22). After the £2,000 you will have to pay 7.5%/32.5%/38.1% on the remaining dividends. This depends on your tax band (basic/higher/additional rate) and the rest of your income. Irrespective of this, it is clear that the taxes paid on your dividends are significantly lower than the comparable income tax. However, keep in mind that the ‘allowance’ which is £2,000 in the case of dividends, is much higher at £12,000 for a salary income.

It is worth keeping in mind that you must be a shareholder in the business to receive a dividend in exchange for your investment risk. A director who is not a shareholder cannot receive a dividend.

Summary

It is always advisable to seek professional advice from an accountant on what your best tax options are for either taking a salary, a dividend or both. Each individual has different circumstances and the best way to make sure you are getting the best advice, is to reach out and check with your accountant.

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