Starting a limited company is a preferred option for most people opening a businesses, however this can present you with a challenging situations such as what salary should you pay yourself.
One of the differences between being paid by an employer and running your own business is having to sort out how your limited company pays you. The most tax-efficient way you can do this is by taking a combination of a low salary and dividends from your limited company. This salary will be paid to you as a director, in the same way as a regular employee.
You’ll need to make sure that you meet all your reporting and tax filing responsibilities for running your payroll under HMRC’s Real-Time Information (RTI) rules or you may incur fines and penalties. You’ll also need to make sure you follow HMRC’s rules on issuing dividends.
If you’re a business owner and would like some advice, get in touch with us. We are here to help you.
How to pay yourself as a director
There are two main reasons to take a salary from your limited company:
- Salary is an allowable business expense, which means it lowers the amount of Corporation Tax your company pays.
- If the salary is above the Lower Earnings Limit of £6,396 you accrue qualifying years towards your state pension.
Why take a low salary?
Under HMRC’s rules, ‘office holders’ (ie. people who hold a position at a company but don’t have a contract, or receive regular salary payments) aren’t subject to the National Minimum Wage Regulations unless there‘s a contract of employment in place.
A low salary can be paid which means you do not have to pay Income Tax or National Insurance Contributions (NICs) on that salary.
As a UK taxpayer, each year you’ll have a Personal Allowance – any income you receive up to the Personal Allowance is free from Income Tax. In the 2022/23 and 2023/24 tax years, this threshold is £12,570.
There are also National Insurance (NI) thresholds to be aware of. They’re all currently lower than the Personal Allowance and are important when setting your salary:
- The Lower Earnings Limit – as long as your salary is set above this level, you’ll retain your State Pension contribution record
- The National Insurance (NI) Primary threshold – as long as your salary is below this level, you won’t need to pay any employee’s NICs
- The National Insurance (NI) Secondary threshold – as long as your salary is below this level, your limited company (as your employer) won’t need to pay any employer’s NICs.
The aim is to set your salary at a level that is above the Lower Earnings Limit to obtain the benefits of qualifying for the state pension, but below the level where you’ll need to pay either employee or employer’s NI. Win, win!
How do National Insurance thresholds affect a director’s salary?
For the 2022/23 tax year, if your salary is above the National Insurance (NI) ‘Lower Earnings Limit’ (£6,396) but below the NI ‘Primary Threshold’ (£9,880 per year and £12,570 from July 2022), you don’t pay employee’s NI contributions, but you do retain your State Pension contribution record. However, your limited company would have to pay employer’s NI contributions on any salary above the NI ‘Secondary Threshold’ which is £9,100.
In the 2023/24 tax year the ‘Lower Earnings Limit’ is £6,396, the NI primary threshold is £12,570 per year and the NI secondary threshold is again at the lower level of £9,100 and will remain at that level for the full tax year.
This means that the most tax-efficient salary for a limited company with a single director who has no other sources of taxable income for the 2022/23 and 2023/24 tax year will usually be £755 per month (£9,100 for the 2022/23 tax year) which is the NI Secondary threshold amount.
Why take a higher salary?
If your salary is set at a very low level, or if you don’t take a salary at all, there are disadvantages, such as:
- Reduced maternity benefits. To qualify for maternity benefits, you need to be “employed” and thus be compliant with the National Minimum Wage Regulations
- You could miss out on part of your annual tax-free personal allowance if your salary is paid at the NIC threshold and you have no other sources of income. (You should ensure that you understand the impact of the total amount of salary and dividends you take from your company and other sources of income on your available tax-free personal allowance)
- Reduced cover under permanent health, critical illness, personal accident or similar policies, where payouts are calculated based on your earnings
Paying yourself in dividends
If your company makes enough profit, then you have two options available. You can either reinvest your profit into the company or pay shareholders (owner(s) of the company) by issuing a dividend.
If you own and manage your limited company, you can pay yourself a dividend. This can be a tax-efficient way to take money out of your company, due to the lower personal tax paid on dividends.
Through combining dividend payments with a salary, you can ensure that you’re at optimum tax efficiency.
Tax implications of taking a salary
As with regular full-time employees, all salaries will be subject to tax via Pay-as-you-earn (PAYE). With three separate PAYE ‘taxes’, the benefit of reducing your Corporation Tax liability by taking a higher salary can soon be outweighed by the additional tax paid.
Income tax
Income tax is cumulative on all employment earnings and other sources of income in a tax year. For example, if you’ve already earned £12,000 from any employment in a given tax year, your tax-free Personal Allowance will be reduced by this amount.
You can check out our tax rates and thresholds here.
Employee National Insurance contributions
Unlike Income Tax, employee National Insurance Contributions (NICs) aren’t cumulative. They are payable for each pay period. This means each new employment has a separate earnings threshold before NICs are due. For employees who are Higher Rate taxpayers, there’s a maximum limit on the amount of NICs to be paid.
If you’re an employee (but not a director), this threshold is set as a monthly amount. If you’re paid over this amount in any given month, you’ll have to pay NICs even if your pay for the rest of the year is reduced.
Employer National Insurance contributions
The threshold for employer NICs works in the same way as employees. For every salary amount your employee earns above the weekly National Insurance earnings threshold, the employer has to pay NICs at 13.8% for the 2023/24 tax year (14.53% for 2022/23). This also applies to your own director’s salary and represents another PAYE tax the company has to pay.
To sum it all up
It is usually tax-efficient for most limited company directors to take a monthly salary up to the NI Secondary threshold of £758.33 per month, or £9,100 per year.
As the Lower Earnings Limit is below the point at which you pay employee or employer’s NICs, you’ll still accrue qualifying years for the state pension.
If you pay yourself a salary up to the relevant National Insurance threshold from your limited company, you won’t pay any Income Tax or National Insurance on it as long as it’s your only earnings.
As a company director, you can choose the amount of salary you’re paid, but you may wish to get advice from one of our experts to ensure you’re paying yourself in the most tax-efficient way. If you’re interested in finding out more, call us on 01865 548465 or use our online contact form.
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