Directors of limited companies have many legal obligations – and must also decide whether they want paying in dividends or salaries.
Many choose to take a mix of each, but what is best for you? And is there a difference?
Dividends and salaries are both ways for the directors of companies to extract profits from the business. It often depends on the roles you have within the company that results in how you extract profit.
Dividends or salaries?
A dividend is a share of the profits of the company. Effectively, it is distributing the money remaining after a business has settled all its liabilities, including taxes.
Salaries are paid to you as part of an employment contract for work you carry out.
There are pros and cons to each. So, to help you decide which is best for you, let’s look further.
As we have said, a dividend is a share of the firm’s profits. If the business has no profit after paying all its liabilities and taxes, it cannot pay dividends.
Dividends are paid to directors and shareholders and is in proportion to the shares they hold. You do not have to pay dividends even if you make a profit. Some boards of directors choose to keep the profits over a number of years before distributing them.
National Insurance is not payable on dividends and they attract lower tax rates than standard salaries. As a result, they are often chosen to extract profit rather than a salary.
You do not pay tax on the first £2,000 per annum of dividends and then the rate is 7.5% or 32.5% depending on income. Only shareholders are allowed to take dividends as a reward for investment. If any directors are not shareholders they cannot receive dividends.
Pros of dividends
- You do not pay NI contributions on dividends
- The income tax rate is lower than salaries
- Taking most of your income in dividends means your income tax can be lower
Cons of dividends
- Dividends are paid out of profits. If you have no profit, you’ll have no income
- Depending on them for income can be unpredictable
- They are not classed as ‘relevant earnings’ for the purposes of tax relief on some pension contributions
- If you pay a dividend not covered by profits, it could be classed as a director’s loan and needs repaying
Most people who work are paid a salary, or wage. If a director is employed to carry out regular work, then they probably need paying a salary.
In such cases, you need to ensure there is an employment contract that complies with National Minimum Wage laws. Directors can be paid a salary of £8,788 per annum (2020/21) without paying NI but they still qualify for pension and sickness benefits.
Businesses that use Employers Allowance due to having additional employees may consider paying a director the annual personal allowance of £12,500 a year.
Company directors should consider taking a small salary, as it means you will be added to the firm’s payroll.
Pros of salaries
- You will be paid even if your company doesn’t make a profit
- It can be easier to apply for mortgages and insurance policies
- Higher personal pension contributions can still be made
- You can build up qualifying years towards your state pension
Cons of salaries
- You will be paying a higher rate of income tax than a dividend
- A salary means you and your company pays NI contributions
Which is best?
There’s a saying that you pays your money you take your choice! That’s not the case when it comes to salaries and dividends. It is very much a personal decision based on individual circumstances.
Before rushing in and deciding, speak to an accountant or tax expert as they can calculate better based on your circumstances.
If you want to know more about our services for company directors, contact us today.