For a higher number of self-employed workers, launching a limited company seems like the perfect next step. While making the move from being a sole trader to a limited company can make managing your business processes somewhat easier, there’s also a few formalities that you will need to get your head around. 
One key difference between being employed and paid every month by an employer or being paid directly by clients as a freelancer and moving to being a limited company is working out how to pay yourself from your limited company - you take a salary in the same way that you would pay an employee, but you are also in a position to combine it with dividends. 

Why should you take a salary? 

There are a number of benefits of taking a salary from your limited company, however the main two of these are: 
 
A salary is an ‘allowable business expense’ which means it reduces the amount of tax that your business will need to pay. 
If the salary amount that you pay yourself is higher than the ‘Lower Earnings Limit’ - which is £6,136 for the current tax year - you get qualifying years that can go towards your state pension. 
You need to choose a salary type - high or low? 
 
The current personal tax allowance is £12,500 - this is the amount that you can earn each year without having to pay tax. It’s worth noting that the National Insurance threshold is set somewhat lower than this threshold, so depending on what you pay yourself, you may still need to cover this cost. 
 
Under current legislation, ‘office holders’ - aka people who have a position at a company but aren’t contractually employed by that company or receive monthly salary payments - don’t have to meet the National Minimum Wage regulations. This means that you can pay yourself a small amount, which should then mean that you don’t need to make National Insurance payments, saving you money. 
However, if the salary that you pay yourself is too low, there are a number of disadvantages that it is worth taking note of. For instance, to qualify for maternity benefits, you need to be earning the National Minimum Wage and be properly employed. 
 
You may also lose out on part of your tax-free personal allowance. Furthermore, you may find that your insurance coverage is reduced as a result of your earnings being reduced. Another problem with paying yourself too low a salary is should you apply for a loan or mortgage, your income may impact your ability to successfully apply. However, it’s important to note that there are ways to get around this issue, such as looking at specialist mortgages for people who are self-employed

How to pay yourself in dividends 

Should your company make a profit, you have two options to consider. You can either take this profit and put it back into the company, investing it in your business, or you have the option to pay shareholders, such as yourself, by creating a dividend. 
 
As an owner of your business, you have the right to pay yourself a dividend. Dividends can act as an efficient way to take money out of your business and boost your income in a quick and easy way. By taking a small salary and using dividends to pay yourself, you can reduce the amount of tax that your business needs to pay and increase the income that you receive. 

Does taking a salary have tax implications? 

All salaries, regardless of their size, are subject to tax and NI via the Pay As You Earn (PAYE) system, which means that if you take a higher salary you will end up paying more in tax and NI.  
 
Taking note of the above information, for most business owners it’s normally a good idea to pay themselves a salary that meets the Primary or Secondary National Insurance Threshold. This is because, as the Lower Earnings Limit is less than the National Insurance Primary threshold, you are still able to gain qualifying years for a state pension. 
 
By choosing to pay yourself a salary at this level from your company, you will avoid paying Income Tax or National Insurance, as long as it is the only income you receive. If you want to be tax efficient, this option tends to be the best route to go down as it means you will pay less in regards to tax and will be able to keep more of your income. 
 
As the director of your company, you have the power to choose how much you pay yourself! 

Our advice for the year ahead... 

Many small business owners, contractors and freelancers choose to operate through a limited company – and one of the biggest reasons for this is tax efficiency. For this reason, a key piece of tax planning is around the level of salary and dividends you withdraw. Setting the right salary and dividend plan in place can save a significant amount in tax! It is quite complex; so this is where we come in. 
 
PLEASE NOTE: The advice below is aimed at those who are a UK tax resident working through their own company, who are outside IR35, and have no other sources of income. If this isn’t you, your tax affairs may be more complex, and we would need to put together a tailored plan. Please get in touch with us today if you'd like to discuss this in more detail. 
 
Key rates & thresholds 
 
2020/21 
2019/20 
Personal Allowance 
This is the amount you can earn tax-free in a tax year 
£12,500 
£12,500 
Dividend Allowance 
This is the amount of dividends you can earn tax-free in a tax year (in addition to the Personal Allowance) 
£2,000 
£2,000 
Basic Rate Threshold 
This is the amount you can earn and pay basic rate tax; above this, you start to pay higher rate tax 
£50,000 
£50,000 
National Insurance 
 
2020/21 
2020/21 
2019/20 
2019/20 
 
Amount 
Rate 
Amount 
Rate 
Lower Earnings Limit 
If you earn less that this, you will pay no National Insurance AND will not qualify for entitlement to state pension and benefits 
£6,240 
N/A 
£6,136 
N/A 
Primary Threshold 
If you earn above this, you PERSONALLY start to pay National Insurance 
£9,500 
12% (if above) 
£8,632 
13.8% (if above) 
Secondary Threshold 
If you earn above this, the COMPANY as your EMPLOYER will start to pay National Insurance 
£8,788 
13.8% (if above) 
£8,632 
13.8% (if above) 
So, the optimum salary needs to be: 
 
1. No more than the Personal Allowance to avoid paying personal tax. £12,500 
2. Above the Lower Earnings Limit so you get a qualifying year for NI £6,240 
3. Below the Primary Threshold so you don’t have to pay any Personal NI. £9,500 
 
So, for 2020/21, the most tax efficient salary is £9,500 for the year. This equates to £791.67 per month. 
 
On this basis, your company will need to pay a small amount of Employers NI in March 2021 (approximately £98) and we will contact you at that time. 
 
Any AFTER TAX PROFIT – i.e. the money the company has remaining after paying all business expenses and liabilities plus any outstanding taxes, can be paid to you (and any other shareholders) in dividends. Personal tax on dividends is lower than that of a salary, so they can be a tax-efficient way to take money out of your company once you’ve hit the salary limit. 
 
For 2021/21, in addition to the above salary, you can earn: 
 
£5,000 of dividends tax-free 
£35,500 of dividends at the Basic Rate of 7.5% 
Any dividends above this will be taxed at 32.5% 

Next steps 

It can be complicated figuring out how to pay yourself a salary in the most tax efficient way, so why not give us a call or drop us an email? We’ll be more than happy to help advise you, taking your individual circumstances into consideration. We’ll explain your options in simple, understandable terms, and help you come to an informed decision based on your specific situation. 
 
DISCLAIMER 
The information contained in this blog post is for general information purposes only. The information is provided by Effective Accounting Solutions Ltd and while we endeavour to ensure that the information contained in this blog post was up to date and correct at the date of publication, we make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability or availability with respect to the blog post or the information, products, services, or related graphics contained in the blog post for any purpose. Any reliance you place on such information is therefore strictly at your own risk. In no event will we be liable for any loss or damage including without limitation, indirect or consequential loss or damage, or any loss or damage whatsoever arising from loss of data or profits arising out of, or in connection with, the use of this blog post. 
 
 
 
 
Written by 
 
Nicola J Sorrell - 
Effective Accounting 
 
Founder | Xero Champion | IR35 Expert 
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