A comprehensive yearly review enables you to assess and adapt your strategy according to current circumstances, ensuring you continue maximising tax efficiency.
An accountant or financial advisor can provide valuable assistance in this annual review, helping navigate the complexities of tax laws and advising on the most suitable approach for your situation.
When it comes to being compensated at work, everyone loves a tax-efficient option. Salary vs dividends or remuneration vs dividends is an ongoing debate in the minds of many company directors in the UK. For them, a double consideration is involved – their personal tax bill and the company’s tax bill.
Therefore, the goal for directors is to understand the dynamics between salary vs dividends and to pay themselves in a way that optimises both. Luckily, there are ways to do so. Here, we offer a quick guide to compensation for company directors and how to strike the perfect balance between remuneration and dividend.
But first, let us get the definitions out of the way:
What is remuneration?
Remuneration is essentially the same as a salary – directors put themselves on the company payroll and issue themselves an amount like any other employee. It is subject to income tax and the National Insurance Contribution (NIC).
What is a dividend?
When we consider salary vs dividends, the latter is dispensed from the company’s post-tax profits, the latter is issued out of the company’s post-tax profits. Directors take dividends based on the number of company shares they hold. They are subject to income tax but not NI contributions.
Pros and pros of taking remuneration
Choosing remuneration vs dividends is a significant decision. It is generally a good idea for directors to pay themselves a salary, even if it is nominal. The advantages include:
- Reduced corporation tax (salary is a deductible expense)
- Salary paid even if the company does not make a profit
- Easier to apply for mortgages and insurance coverage
- Qualifying years added towards state pension
- More personal pension contributions
- Maternity benefits retained
However, remuneration will attract higher income tax rates than dividends, and you and the company must pay NI contributions.
On top of that, it requires more complex administrative work. This includes regular payroll setup, reporting to HMRC, and compliance with Real-Time Information (RTI) regulations.
Plus, the more income you take as salary, the less retained profit is left in the company for potential future investment or to serve as a buffer in financially difficult times.
When contemplating remuneration vs dividends, you must consider several pointers:
- You do not pay income tax unless your salary crosses the personal allowance of £12,570
- The primary threshold for NI contributions is also £ 12,570. For salaries beyond this, NI kicks in
- For salaries higher than £9,100, the company will have to make an NI contribution
- To build up your qualifying years for state pension, your salary must be at or above the NIC Lower Earnings Limit of £123 per week or £533 per month for 2023/24
Some directors, keeping in mind the salary vs dividends dynamics, choose to pay themselves a salary between the Primary Threshold and the Lower Earnings Limit. This helps them avoid paying NIC while keeping their state pension.
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Pros and cons of taking a dividend
As a payment issued only after a company has paid its taxes and has profit left over, dividends attract lower income tax rates.
For 2023/24, the tax-free dividend allowance is £1,000, beyond which the rates are 8.75% (basic tax rate), 33.75% (higher tax rate) and 39.35% (additional tax rate).
In addition, neither you nor the company must pay NIC on dividends. However, there are certain drawbacks of taking dividends as payment, including:
- A dividend is only payable if profits are left over after paying corporation tax, making it an unreliable source of income
- If you take out a dividend outside of profits, it counts as a director’s loan, and you must repay it
In the salary vs dividends debate, some factors to evaluate for dividends include:
- It might be beneficial to take a small salary up to the tax-free personal allowance or just enough to maintain your NI record, and then take the rest of your income as dividends
- Ensure your company has enough profits after tax to cover the dividends. If your company pays dividends from retained earnings, it must have sufficient profits to do so, otherwise, the dividend may be illegal
- Be mindful of how taking dividends might push you into a higher tax band. You may want to spread dividends across several tax years to manage this
- Consider whether it might be more beneficial to reinvest profits back into the company for growth, rather than take them as dividends
- If your spouse or family members are shareholders in the company and they have not used their tax-free dividend allowance, you may want to consider distributing dividends to them
An additional option: Pensions
Apart from the remuneration vs dividends equation, an employer pension contribution is a third option for your compensation as a director. The company pays these contributions directly into your account. The advantages include:
- No employer NICs to pay
- Not limited by how much salary you are making
- Reduction in corporation tax bill as they are an allowable expense
- If your spouse or family members are shareholders in the company and they have not used their tax-free dividend allowance, you may want to consider distributing dividends to them
The drawback, of course, is that you cannot access your pension contributions until you are 55, so they cannot be a substitute for the remuneration vs dividends alternative.
Conduct a yearly review
A salary vs dividends strategy that worked for remuneration and dividends this year may not necessarily work next year. Multiple factors can influence this.
Changes in tax laws, alterations in the personal allowance, adjustments in corporation tax rates, and modifications to dividend tax thresholds are just some variables that can impact the optimal balance of salary and dividends.
A comprehensive yearly review enables you to assess and adapt your strategy according to current circumstances, ensuring you continue maximising tax efficiency.
An accountant or financial advisor can provide valuable assistance in this annual review, helping navigate the complexities of tax laws and advising on the most suitable approach for your situation.
In addition, the financial position and profitability of the company can change year by year. In a profitable year, paying a larger proportion of income as dividends may make more sense, whereas, in a less profitable year, a larger salary might be more advantageous.
A comprehensive yearly review enables you to assess and adapt your strategy according to current circumstances, ensuring you continue maximising tax efficiency.
An accountant or financial advisor can provide valuable assistance in this annual review, helping navigate the complexities of tax laws and advising on the most suitable approach for your situation.
Consult a professional to avoid complications.
You will likely end up paying yourself a mix of remuneration and dividend to optimise how much you take home. However, there is also the paperwork to take into account.
Company tax laws can be hard to navigate anyway, and HMRC has recently tightened its checks on how dividends are paid. Plus, you will need to consider the increased rate of corporation tax.
Trying to salary vs dividends by yourself can be cumbersome, and there is always the chance that you may miss something – which is why we recommend working with an experienced accountant practice like Bradleys Accountants.
From deciding on the ideal dividend amount to maintaining complete payment records to submitting returns in accordance with HMRC and Companies House requirements, they can do it all.
Reach out to our professional accountants today and save yourself time and trouble while ensuring you are compensated fairly for the work you do as a director. Good luck!
