Whether you are new to contracting, or feel like you have been in the market forever, it’s always good to make sure that you have the most tax efficient set up for your company. To do that you need to understand salary vs dividends and what the tax implications are of both forms of remuneration. This then enables you to take home as much of your hard earned money as possible.
Dividends is one of the key benefits to being a limited company contractor. Some of the most common questions we get asked are. . .
What is the most tax efficient way to pay myself?
Should I pay myself through solely a salary?
Should I pay myself through a combination of salary and dividends?
How often should I withdraw dividends?
It’s important to understand if, and how dividends could work for you, or if indeed a straightforward salary would be better. So let’s take a closer look at salary vs dividends.
How do dividends work?
Shareholders of a company are entitled to dividends. For ordinary shares, the amount of dividends a shareholder can receive is based on the percentage of shares owned. So if you are the only shareholder, you’ll receive 100% of each dividend; if you own three quarters of the company you’ll receive 75% of each dividend etc.
What are the dividend tax thresholds?
You can currently take up to £500 in dividends (in the 2024/25 financial year) before having to pay tax on them. After that, tax is charged as follows:
- Basic-rate taxpayers will pay 8.75% (covering income up to £50,270)
- Higher-rate taxpayers will pay 33.75% (covering income between £50,270 and £125,140)
- Additional-rate taxpayers will pay 39.35% (covering income over £125,140)
HMRC have an example of how dividends work alongside other income. It is worth noting here that these rates are lower than income tax rates.
What is the benefit of paying yourself through a combination of a salary and dividends?
This is where it gets interesting in terms of what it can mean for you and your business.
Simply put, by taking a minimum salary and the balance in dividends, most contractors will end up paying significantly less combined tax and National Insurance Contributions than those paying themselves just a salary.
The key benefits to note are:
- you don’t pay National Insurance on dividends
- you can minimise your personal tax liability (depending on how many dividends you pay yourself)
- taking a salary triggers a national insurance record for your state pension
- your company can claim the cost of your salary when it calculates its corporation tax making a saving for the business
- you can pay yourself in dividends up to the level of post-tax profit in your company
Why is it not recommended to just have a salary?
By paying yourself through a combination of both salary and dividends you will maximise the tax benefits of combining both. By just paying yourself through salary (higher than the National Insurance threshold) you’ll need to pay both employer’s and employee’s NIC’s. This will be taken as a proportion of your earnings.
The tax allowance for salary is as follows:
- personal allowance means you pay nothing up to £12,570
- basic-rate taxpayers will pay 20% (if you receive salary up to a value of £50,270)
- higher-rate taxpayers will pay 40% (if you receive salary up to a value of £125,140)
- additional-rate taxpayers will pay 45% (if you receive salary over £125,140)
… notably more than the rates on dividends.
Salary vs dividend – Take Home Pay
The below case study provides a breakdown of the tax deducted and the final take home pay from each scenario.
Salary Only
| Gross Income (Salary) | Tax | NI | Take home |
|---|---|---|---|
| £45,000 | £6,486 | £2,594 | £35,920 |
| £50,270 | £7,540 | £3,016 | £39,714 |
| £55,000 | £9,432 | £3,111 | £42,457 |
| £70,000 | £15,432 | £3,411 | £51,157 |
Salary and Dividends
| Gross Income |
Salary | Dividends | Tax | NI | Take home |
|---|---|---|---|---|---|
| £45,000 | £12,570 | £32,430 | £2,794 | – | £42,206 |
| £50,270 | £12,570 | £37,700 | £3,255 | – | £47,015 |
| £55,000 | £12,570 | £42,430 | £4,851 | – | £50,149 |
| £70,000 | £12,570 | £57,430 | £9,191 | – | £60,809 |
In conclusion, it’s not so much a question of salary vs dividends, rather a happy combination of the two! Owning your own company comes with benefits, one of which is the ability to control when you remove funds from your business, how much and the timing of tax. With advice from your accountant you’ll be able to maximise these benefits and run your business as efficiently and profitably as possible.
For more information on dividends, why not take a look at our Contractors Guide to Dividends or speak to one of our qualified accountants on 0207 096 2659.