How to pay yourself smarter as a director
The How Do I Pay Myself Question
If you’re a director of a limited company then you’ll know that working out how to pay yourself, which methods to use and how much to allocate to each can feel a bit like putting a puzzle together.
Should it be salary, dividends or maybe a bit of both?
And while you’ll often hear the typical answer of “it depends” there are some smart guiding principles to follow, especially if you want to save tax, stay compliant and keep cash flowing smoothly.
Salary vs Dividends – The Classic Combo
For most directors, though this may be different if you are actively applying for mortgages, the standard approach is to take a small salary through PAYE (using up the current tax years personal allowance) and then top it up with dividends covered by company profits.
The salary keeps you within the PAYE system, maintains your NI record and reduces your company’s taxable profits as salaries are allowable for corporation tax.
Dividends are taxed at lower rates than PAYE income but they’re not allowable for corporation tax however the tax saved by using dividends usually outweighs the fact that they’re not deductible.
Where People Get Caught Out
This where the ‘it depends’ really kicks in, here are a few common traps:
- Taking too low a salary and missing out on state pension credits or not making the most of your tax free allowance
- Forgetting that dividends need to be backed by profit and declared properly, if your net assets can’t cover the dividend it can create issues with overdrawn director’s loan accounts
- Ignoring employer pension contributions as part of the picture
- Taking large one off dividends without thinking about the tax impact or timing in the tax year
- Not understanding the impact on mortgage applications or other loan and credit facilities
The impact of these issues often doesn’t show up until it’s too late and by then they’ve already cost you which is why it’s critical to plan ahead and come up with the right blend for your situation.
What Smarter Actually Looks Like
Smarter doesn’t mean using complex or outlandish tax optimisation schemes, it just means taking stock of your own situation and what matters most to you over the next one to three years and acting with intent.
Instead of only thinking about what saves tax today, think about how each part of your pay fits into your wider life goals and short to medium term personal finance strategy including things like:
- Whether you want to apply for a mortgage or borrow finance
- Whether you’re happy to minimise tax even if it affects affordability
- Whether you need to draw money out of the company for a one off personal project or expense
- How profitable the company is in terms of covering dividends
Final Thoughts
There’s no single best way to pay yourself, only the right mix for your business, your income and your goals.
Still not sure if you’ve got it setup in the smartest way for your situation?
Feel free to get in touch and arrange a consultation, we’ll help you work thorugh the options and take care of the numbers so you can focus on what you do best.
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