How Do I Pay a Mix of Salary and Dividends?

You have three options: a salary, dividends or both. The answer depends on how much you intend to withdraw from the business and if you have other income, but in general, a combination of a small salary and dividends is optimum. 

What salary should I pay?

We’ve outlined some common scenarios and the salary/dividend mixes that are appropriate for each. At the end we’ve also linked you to our tax calculator in case you want to see the actual calculations or model your own scenario.

The secondary earnings limit

Directors with no other income should look to pay themselves a salary of £8,788 (£732/month) during the 2020/21 tax year. This is the secondary earnings limit for National Insurance meaning you will not have to pay either employer’s or employee’s NI and you will not pay any Income Tax. The other benefit of paying this salary is that it is a deductible tax expense, a salary of £8,788 will save you £1,670 in Corporation Tax.

There is a second reason to at least pay a salary at this level, which is to ensure you gain a qualifying year for the state pension. The minimum annual earnings required is actually slightly lower than the secondary earnings limit (in 2021/22 it is at £6,240). It is well worth making sure your salary is at least at this level.

The dividend allowance

The next low hanging fruit is to use your £2,000 annual dividend allowance, but note that dividends must be paid from profit and retained earnings (including any corporation tax due for the current year).

Understanding the taxes that apply

Beyond the salary and dividend described above, you will progressively pay more and more tax on whatever you extract. So you will normally optimise for how much cash you need, and how much cash you want to leave in the business or how tax efficient you want to be. This depends on a couple of unknowns: how you think the business’ profit will change and your level of other income in future.

So, what should you do after you’ve paid salary up to the secondary earnings limit and used your dividend allowance?

Take dividends, not salary

First, the main thing is to understand that any remuneration after this level will almost always be more efficient taken as a dividend. The tax bill for each pound sterling taken as a dividend is based on corporation tax and the personal dividend tax rate, whereas for salary it’s income tax, plus employers national insurance and employees national insurance.

For a UK individual, with few exceptions, after you’ve paid salary up to the upper earnings limit, dividends are the more tax efficient way to go.

Progressively higher taxes rates apply

The level of income or dividend tax you pay depends on your total income in a tax year. The main thresholds are your personal allowance rate, basic rate band, higher rate band, and then additional rate band.

Depending on how much cash you want to leave in the business, you’ll typically aim to pay yourself up to the top of one of the above bands. As a client we’ll normally help you figure out what the right level is for you based on your circumstances, but you can also check request our tax calculator and optimiser tool yourself.

Employer’s Allowance

If you employ multiple employees, HMRC provide an employers allowance, which allows you to reclaim up to £4,000 of Employer’s National Insurance contributions. This changes the efficient salary range from £8,788 to being slightly higher (depending on how many additional employees you have). This is a slightly involved process so check with your accountant whether this is something you would benefit from claiming.

Getting in touch with our payroll team

For further advice and if you would like us to run your payroll please get in touch with our payroll team.