How to Pay Yourself as a Director - Salary, Dividends & More

As a director of a limited company, one of the most important aspects of managing your business is understanding how to pay yourself. Unlike sole traders, limited company directors are considered separate legal entities from their business. This means you have to follow specific rules and regulations when extracting income from your company. Fortunately, there are a variety of ways to pay yourself, each with its own benefits and drawbacks.

Understanding the Basics of Paying Yourself as a Director

As a director of a limited company, you have two main options for paying yourself:

1. PAYE (Pay As You Earn): This is the traditional method used by employees PAYE, where your salary is processed through the company’s payroll, and tax and National Insurance contributions are deducted.
2. Dividends: If your company is profitable and you hold shares, you can pay yourself dividends, which are subject to different tax rules compared to salaries.

Each method has specific implications for taxation, pension contributions, and administrative responsibilities. Let’s break down each method in detail.

Option 1: Paying Yourself Through PAYE

PAYE is a straightforward way for company directors to receive a salary, similar to how regular employees are paid. Under PAYE, you’ll set a salary, and your company will deduct income tax and National Insurance Contributions (NICs) from your earnings.

How PAYE Works

• Register for PAYE: The first step is to register your company with HMRC to set up a payroll system. Once registered, you’ll receive a PAYE reference number.
• Report Salary to HMRC: You’ll need to report your salary to HMRC using Real-Time Information (RTI) whenever you pay yourself.
• Deductions: National Insurance and income tax will be deducted based on your earnings and the relevant tax brackets.

Advantages of PAYE

• Regular Income: Your salary is predictable, making it easier to manage personal finances.
• Pension Contributions: You’ll accumulate state pension credits, helping you qualify for the state pension.
• No Additional Tax Filing: If this is your only income, you won’t need to file a personal tax return.
• Company Tax Deduction: Your salary is a deductible business expense, which can reduce your company’s taxable profits and lower your corporation tax bill.

Disadvantages of PAYE

• Higher Tax Rates: PAYE salaries are subject to both income tax and National Insurance contributions, making it less tax-efficient compared to other methods like dividends.
• Limited Flexibility: PAYE is less flexible, as you’ll need to pay yourself at regular intervals and submit payroll information on time.
• Administrative Overhead: Running a PAYE scheme involves ensuring you comply with reporting and payment deadlines, which can be time-consuming and may require the help of an accountant.

Option 2: Paying Yourself Through Dividends

Dividends are payments made to shareholders from the profits of the company. As a director, you may also hold shares in the company, allowing you to pay yourself dividends.

How Dividends Work

• Eligibility: To pay dividends, the company must be profitable, and you must be a shareholder. You can only pay dividends from after-tax profits.
• Decision Process: The board of directors must formally declare dividends at a meeting, and the distribution must be recorded in the company’s minutes.
• Taxation: Dividends are subject to different tax rates than salaries and do not require National Insurance contributions.

Advantages of Dividends

• Tax Efficiency: Dividends are generally taxed at a lower rate than salaries and are not subject to National Insurance contributions, making them a tax-efficient way to extract funds from your company.
• Flexibility: You have more control over when and how much you take as dividends, depending on the company’s profits.
• No PAYE System: Unlike PAYE, there is no need to run a payroll system, which reduces administrative burdens.

Disadvantages of Dividends

• Profit Dependent: Dividends can only be paid if your company is making a profit. If the business is struggling or doesn’t have enough cash flow, you may not be able to take a dividend.
• Lack of Pension Contributions: Dividends don’t count towards your state pension, which could impact your future pension entitlement.
• Additional Tax Filing: If you earn over £500 in dividends, you will need to file a personal tax return and pay tax on the dividends received.

Option 3: Combining PAYE and Dividends

Many directors choose to use a combination of both salary and dividends to pay themselves. This approach allows you to balance the benefits of both methods while mitigating the disadvantages.

How to Combine PAYE and Dividends

1. Salary: You pay yourself a modest salary through PAYE, typically set below the National Insurance threshold to avoid excessive NICs. This ensures you still build up state pension credits.
2. Dividends: After paying yourself a salary, you can top up your income with dividends, provided your company has sufficient profits. Dividends will be taxed at a lower rate compared to salary, which can result in overall tax savings.

Advantages of Combining PAYE and Dividends

• State Pension: By paying yourself a small salary, you can still qualify for the state pension without paying excessive National Insurance.
• Tax Efficiency: The dividend portion of your pay is subject to lower tax rates, saving you money compared to paying yourself entirely through PAYE.
• Flexibility: You maintain the flexibility of taking dividends when the company can afford to pay them, while still having a steady income from your salary.

Disadvantages of Combining PAYE and Dividends

• Increased Administration: You’ll need to manage both salary payments through PAYE and dividend payments, which may require extra bookkeeping and filing.
• Pension Limitations: Although you’ll be entitled to some state pension credits, the small salary might not be enough to ensure the maximum state pension.

Tax Considerations for Directors

One of the most critical factors in deciding how to pay yourself is tax efficiency. Both PAYE and dividends have tax implications that can affect your take-home pay.

• Income Tax: Both salaries and dividends are subject to income tax, but the rates differ. Salaries are taxed according to the personal income tax bands, while dividends are taxed at a lower rate.
• Salary Tax Bands (2024-25):
• Personal Allowance: £12,570 (taxed at 0%)
• Basic rate: 20% on income from £12,570 to £50,270
• Higher rate: 40% on income from £50,270 to £150,000
• Additional rate: 45% on income over £150,000
• Dividend Tax Rates (2024-25):
• £2,000 tax-free allowance
• Basic rate: 8.75% on dividends above £2,000
• Higher rate: 33.75% on dividends above £50,270
• Additional rate: 39.35% on dividends over £150,000
• National Insurance: Salaries are subject to National Insurance contributions, which fund state benefits and pensions. Dividends are not subject to National Insurance, making them a tax-efficient choice for higher earnings.
• Corporation Tax: The salary you pay yourself is deducted from your company’s taxable profits, reducing your corporation tax bill. Dividends, on the other hand, are paid from after-tax profits.

Other Considerations

• Pension Contributions: If you pay yourself through PAYE, you can contribute to a pension scheme through salary deductions. This can be a tax-efficient way to save for retirement. Dividends do not allow for pension contributions, so if you prioritize retirement savings, a salary might be preferable.
• Admin and Accounting Costs: Running a PAYE scheme and issuing dividends both come with administrative costs. While PAYE requires setting up payroll software or using an accountant, dividends require formal documentation, such as board minutes and dividend vouchers.
• State Benefits: A salary contributes towards your state pension, while dividends do not. If you’re planning to rely on state benefits or your pension, it’s essential to maintain a salary above the minimum threshold.

Conclusion: Which Option Is Right for You?

There is no one-size-fits-all answer to how you should pay yourself as a director Payroll. The best choice depends on your company’s profitability, your tax situation, and your long-term goals.

• If simplicity is key, paying yourself entirely through PAYE may be the best option, especially if your income is straightforward and you want a consistent, predictable income.
• If tax efficiency is a priority, you might want to lean towards dividends. By taking a small salary and the rest as dividends, you can minimize tax liabilities and keep more of your income.
• A combination of both methods offers flexibility and tax efficiency, ensuring you benefit from both salary and dividend advantages.

For more details on how outsourcing your payroll can simplify these processes, check out our article on Payroll Outsourcing - Why Should Businesses Opt for It?.