What’s the most tax-efficient way for company directors to take income? If you run a company (even if it’s a one-person contractor company) there are three different ways that you can choose to pay yourself: salary, dividends and pension contributions.

• How should I take an income from my company?
• Taking a salary from your company
• Taking dividends as income
• Receiving pension contributions directly from your company

In particular, we’ll look at the tax advantages of dividends and pension contributions, along with the limitations of these forms of remuneration.

How should I take an income from my company?

Most directors of limited companies pay themselves using a combination of salary and dividends, often supplemented by pension contributions from the company. Finding the right combination for you will depend on a number of factors, such as

• The company’s profits
• How much you want to reduce your personal tax bill
• How much you want to reduce the company’s tax bill
• Whether you want to retain certain state benefits (e.g. maternity benefits or state pension)

Taking a salary from your company

As a director, it’s a good idea to take at least a small salary. This means putting yourself on your company’s payroll. There are several benefits of taking part of your income as salary.

The benefits of taking a salary

• You build up qualifying years towards your state pension
• You can make higher personal pension contributions
• You can retain maternity benefits
• It can be easier to apply for things like mortgages and insurance policies such as critical illness cover
• You reduce the amount of corporation tax that your company pays (as salary is an allowable business expense)
• You can take a salary even if your business makes no profit

The drawbacks of taking a salary

• Taking a salary means that both you and the company have to pay National Insurance contributions (NICs)
• A salary attracts higher rates of income tax than a dividend does

Deciding how much salary to take

You don’t pay income tax on your earnings until they pass the personal allowance level (currently £12,570 per annum in the 2023/24 tax year). Neither do you pay employee NICs if your income doesn’t pass the NIC Primary Threshold (currently also set at £12,570 per annum). Employer NICs become payable on any employee earnings above £9,100 per annum.

Note that in order to build up qualifying years for the state pension, your salary must be at or over the NIC Lower Earnings Limit (currently £6,396). Some directors therefore set their salaries between the Lower Earnings Limit and the Primary Threshold, so as to keep their state pension accrual but avoid paying NICs.

Taking dividends as income

Many directors choose to take the majority of their income in the form of dividends, as this is usually more tax-efficient.

What are dividends?

A dividend is simply a share of the company’s profits. Profit is what is left over after the company has settled all its liabilities, including taxes. If there is no profit, then no dividends can be paid.

Dividends can be paid to directors and other shareholders, according to the proportion of shares that they hold. There is no requirement to pay all the profits as dividends, or even any of them. A company can retain profits over a number of years and distribute them as the board decides.

The benefits of taking dividends

• Dividends attract lower rates of income tax than salary
• No NICs are payable on dividends (neither employer nor employee)

By taking most of your income in the form of dividends, you can significantly reduce your income tax bill.

Your dividend allowance

You have a tax-free dividend allowance, which is in addition to your personal allowance. In the 2023/24 tax year this allowance is £1,000. This means that you can earn up to £13,570 before paying any income tax at all.

Income tax rates on dividends

Dividends attract a much lower rate of income tax than salary does. There is also a slightly greater tax-free allowance when you are paid in dividends. Here is a comparison table:

	Basic rate	Higher rate	Additional rate
Salary	20%	40%	45%
Tax threshold:	£12,570 – £50,270	£50,271 to £125,140	£125,141+
Dividends	8.75%	33.75%	39.35%
Tax threshold:	£13,570 – £50,270	£50,271 to £125,140	£125,141+

The drawbacks of taking dividends

Although taking your income mostly in the form of dividends may seem like a no-brainer, there are certain limitations and pitfalls to watch out for.

• Dividends can only be paid out of profits
• Relying too much on dividends can make your income unpredictable
• Dividends are paid after corporation tax has been deducted (unlike salary, which is a tax deductible expense)
• If you accidentally take a dividend that is not covered by profits, you will have taken out a director’s loan which must be repaid
• Dividends don’t count as ‘relevant UK earnings’ for the purposes of tax relief on pension contributions that you make yourself (see below)

Receiving pension contributions directly from your company

A third possible way to receive tax-efficient remuneration is in the form of pension contributions directly from your company. This is different from contributing to your pension yourself, as it counts as an employer pension contribution.

The benefits of making employer pension contributions

• Pension contributions don’t add to your income, so don’t increase your tax bill
• They are an allowable business expense, saving up to 25 per cent in corporation tax
• There are no employer NICs to pay, potentially saving another 13.8 per cent
• Employer pension contributions are not limited by the size of your salary but are subject to the annual allowance limit

The last point above is an important one. As an individual, you will not receive tax relief on any pension contributions that exceed your salary for that year. Therefore, if you are taking a small salary plus dividends (as discussed above) then you can’t pay very much into your pension personally.

However, employer pension contributions are not limited in this way. They are limited only by the annual allowance (currently £60,000). So your company can contribute up to this amount into your pension, even if you are on a small salary. Assuming the finance bill measures go through unchanged. If eligible, carry forward can be used to increase available annual allowance.

The drawbacks of taking employer pension contributions

The main downside of taking remuneration in the form of pension contributions is the obvious one: you can’t access your pension until at least the age of 55. Therefore pension contributions can’t be a substitute for salary or dividends, just a welcome addition to them.

Want to find out more?

Getting the balance right between salary, dividends and company pension contributions is an individual calculation based on personal circumstances so we recommend that before you make a decision you speak to your accountant and financial adviser – we are here to advise and help.

Grosvenor Wealth Management can help guide you through the tax-efficient ways to pay yourself from your company. If you would like to talk to us, please get in touch.

Grosvenor Wealth Management Ltd is authorised and regulated by the Financial Conduct Authority. The value of investments can go down as well as up and you may not get back the original amount you invested. Tax treatment is dependent on individual circumstances and may be subject to change. Tax planning is not regulated by the Financial Conduct Authority.