Choosing whether to pay yourself through dividends vs salary is a big decision. Let’s weigh up the options so you can pick what’s right for you.
(4 minute read)
Today we’re discussing:
- The difference between dividends vs salary
- How they’re taxed
- How to decide which is right for you
Dividends vs Salary: What’s the Difference?
A salary is a fixed regular payment made to employees (including directors) whilst dividends is a share of a business’ profits paid to shareholders.
Business owners are often director-shareholders, meaning you’re both an employee and a shareholder. This position allows you to choose how you’re paid.
There are big tax differences between dividends vs salary, and the right choice depends on your specific business.
A salary is generally a more stable form of income. Your company doesn’t need to make significant profits and you get a reliable wage.
Taking a salary can also help build qualifying years towards a state pension, allowing you to make higher pension contributions and access parental benefits.
You must be an employee to take a salary. This means registering your business as an employer with HMRC and using the PAYE system to pay your wage.
You don’t pay tax on your salary below £12,570. If your salary’s higher salary, tax rates are as follows:
|Earnings Band||Tax Rate on Salary|
|Earnings from £12,571 up to £37,700||20%|
|Earnings from £37,701 up to £150,000||40%|
|Earnings above £150,000||45%|
Remember that tax is based on the portion of earnings within each band. So, if you have a salary of £30,000 you only pay the 20% tax rate on the portion of your income above the Personal Allowance.
Salaries can make you liable for National Insurance contributions which are set to rise by 1.25% later this year. Make sure to factor this into your plan.
However, you can reduce your liability by up to £4,000 if you’re eligible for Employer’s Allowance.
You may wish to pay yourself a small salary that falls below your Personal Allowance, though the tax efficiency of salaries generally decreases as the amount increases.
Dividends are shares of a business’ profits after all taxes and other liabilities are settled. Unlike a salary, your company must be making a profit for you to claim dividends.
As a result, this is generally a less stable form of income.
However, collecting dividends vs salary is often the more tax efficient way to draw money from your company because you aren’t subject to National Insurance, pension contributions and you pay less Income Tax.
However, be aware that dividends are paid after Corporation Tax has been paid whilst salaries are tax deductible expenses.
The amount of tax you pay on dividends depends on your Income Tax band:
|Income Tax Band||Tax Rate on Dividends|
Note: Tax on dividend income will raise by 1.25% in April this year.
Dividends vs Salary: Which is Right for Me?
Typically, dividends become more appealing as the amount you wish to draw out rises.
But often the most tax efficient solution is a combination of salary and dividend income.
Many business owners will pay themselves a salary just below specific tax thresholds, and then extract dividends from the company to bump up their income.
Give us a call at 01772 788200 if you want to reap the most benefits from your business. We can help you navigate tax legislation and maximise your income.
You can also reach us out-of-hours via WhatsApp at 07787 010190 for a rapid response!
Kind regards Ilyas