Salary versus Dividend Remuneration: Making Informed Financial Choices

Following on from our first back-to-basics tax articles for small companies where we spoke about directors’ loan accounts, I now present the second article regarding Salary vs. Dividend remuneration for company owners.

Deciding how to remunerate yourself as a business owner is a crucial decision. If you hold shares in your company, you have two main ways to pay yourself. These are salary and dividends.  Each option comes with its own set of considerations.

Salary Remuneration

A salary is a regular payment made by an employer to an employee. It is important to remember a company is a separate legal entity to its shareholders (owners) and a salary is when you pay yourself as an employee of your own company. When using this option, you should consider:

Taxation: Salaries will give rise to income tax and National Insurance contributions (NICs). These tax rates vary depending on your total income and the tax bands.

Pension Contributions: Salary payments can be used to make personal pension contributions, which can be tax-efficient and help you save for retirement. Additionally, employer contributions are not limited by your earned income, although there are limits over which tax relief on contributions is restricted.

Employee Benefits: You may be eligible for certain employee benefits, such as maternity/paternity and sick pay if you pay yourself a salary. The 2020 Furlough payments also depended on having received ca salary.

UK pension qualifying years: To qualify for any UK State Pension, you generally need a minimum of 10 qualifying years of National Insurance Contributions (NICs). However, to get a "maximum" UK State Pension, you typically need 35 qualifying years.

One of the main ways of earning qualifying years is by taking a salary of at least the NIC lower Earnings Level (Currently £6,396). Receiving child benefits or being a carer will also give qualifying years.

Therefore, if you need to top up your pension qualifying years, paying a small salary is often advisable.

Dividend Remuneration

Dividends are payments made to shareholders out of a company's profits. Business owners who are also shareholders can receive income in the form of dividends provided the company has made sufficient profits to cover the dividend payments.

Tax Efficiency: Dividends have historically been taxed at a lower rate than salaries. However, tax rates on dividends have changed over the years, and they are now subject to dividend tax rates, which vary depending on your overall income.  

No NICs: Unlike salary, dividends are not subject to NICs, which can result in cost savings for both the individual and the company.

Flexibility: Dividends provide flexibility in managing your income and tax liabilities, as you can choose when and how much to distribute, based on the company's profitability.

Choosing Between Salary and Dividend

The choice between salary and dividend remuneration depends on your personal and company circumstances, your decision-making should consider:

Tax Efficiency: While dividends have historically been more tax-efficient, recent changes have narrowed the gap between dividend and salary taxation. Recent changes in corporation tax rules have made the savings even more marginal.

Financial Goals: Consider your short-term and long-term financial goals. If you need a stable income stream, a salary may be more suitable. If flexibility is more important, dividends might be the better choice. 

Ownership Structure: Your company's ownership structure, including the number of shareholders and their shareholdings, can complicate the distribution of dividends. It is important to remember that dividends are paid as a fixed amount per share, therefore without creating different classes of shares, often referred to as alphabet shares, it can be difficult to remunerate individuals at rates that are different from their shareholdings.

 Conclusion

Both methods of remuneration have their own advantages and disadvantages and will depend on your situation, however in most cases, a combination of both salary and dividends would be advisable.