How should a company director pay themselves?

If you run your own limited company, how you pay yourself makes a real difference to your tax bill. The usual answer is a mix of salary and dividends, but the right mix depends on your circumstances.

Why a small salary first

A modest director’s salary is usually a tax efficient starting point. It can be a deductible expense for the company (reducing Corporation Tax), it helps preserve your entitlement to the State Pension and certain benefits by maintaining your National Insurance record, and it makes use of allowances. The salary level is typically set with an eye on the National Insurance thresholds so you secure those benefits without triggering unnecessary NIC.

Then dividends

Once a sensible salary is in place, further drawings usually come as dividends. Dividends are paid out of the company’s post tax profit, are taxed at lower rates than salary, and crucially carry no National Insurance, which is much of their appeal. There’s a small annual dividend allowance (currently £500) taxed at 0%, with dividends above that taxed at the dividend ordinary, upper and additional rates depending on your overall income.

The catch, legality and paperwork

Dividends can only be paid from distributable profits, genuine, available reserves after tax. Paying a “dividend” the company can’t actually afford creates an illegal dividend, which HMRC and Companies House take seriously. You also need the right paperwork: a board minute and a dividend voucher for each payment. Getting this wrong can see dividends reclassified as salary, with NIC and penalties attached.

Watch the director’s loan account

If you draw more than the salary and dividends the company can support, you can end up with an overdrawn director’s loan account. That can trigger an additional tax charge for the company (often referred to by its legislative section) and a benefit in kind issue, an avoidable cost that catches many owners out.

It’s not one size fits all

The optimal blend shifts with:

• Pension contributions, employer contributions can be a very efficient way to extract value.
• Other income, income from elsewhere uses up your bands and changes the maths.
• Student loan repayments, which can be affected by how you’re paid.
• Profit level and cash needs, how much you actually need to draw versus retain.
• A spouse who is genuinely involved, though “income shifting” has rules and must be done properly.

Don’t forget the timing

Spreading dividends across tax years, or timing them around other income, can keep you out of higher rate bands. A little planning before the year end often beats a scramble afterwards.

How we help

We work out the most efficient way for you to pay yourself given your whole picture, salary, dividends, pension and timing, and keep it fully compliant, with the paperwork done properly. The right mix for one director can be quite different for another, which is exactly why it’s worth getting modelled.

This article is general information, not personal advice, and tax rules change over time. For guidance on your own circumstances, get in touch.

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