As a director or business owner, making informed decisions about your personal remuneration is crucial. The two most common methods of extracting profits from your business are through a director’s salary or dividends. These allow you to take a portion of profits from the business, to be used for your own personal finances.
However, recent tax changes, including an increase to 25% in corporation tax, a reduced additional rate threshold for the 2023/24 tax year, and cuts to dividend allowances, have added new considerations to this decision-making process. Working out whether to take a director’s salary or withdraw dividends can be a conundrum.
We delve into the pros and cons of taking out a director’s salary or dividends, while examining the impact of these tax changes.
What Is A Director’s Salary?
A director’s salary is a fixed regular payment made to a director in return for their services to the company. If you’re a director, you’re technically an employee of your own limited company. Employers and employees both pay National Insurance Contributions (NICs) on salary payments, but not on dividends.
What Are The Advantages of Taking Out a Director’s Salary?
National Insurance Contributions (NICs)
A director’s salary is subject to NICs, both from the employer and the employee, which ensures contributions towards the state pension and other benefits. This also supports an individual’s social security with cash benefits for any sickness, unemployment, death of a partner and retirement.
Pension Contributions
A salary allows directors to make personal pension contributions, which can provide tax relief and help build retirement savings. This is essential for future cash planning, especially if you’re nearing retirement and wish to put the necessary components in place.
Mortgage and Loan Applications
A higher salary can bolster your chances of securing favourable mortgage rates or obtaining loans. This is due to lenders often considering a director’s salary as a stable source of income.
What Are The Disadvantages of Taking Out a Director’s Salary?
Higher Taxation
A director’s salary is subject to income tax, which includes personal allowance and higher rate thresholds. With recent changes to the reduced income tax additional rate thresholds (lowering from £150,000 to £125,140) it could result in higher tax liabilities for many directors.
What Are Dividends Payments?
Dividend payments refer to distributions of profits made by a company to its shareholders. When a company generates profits, it has the option to reinvest those profits back into the business or distribute them to its shareholders as dividends. Dividends are typically paid in cash, although they can also be paid in the form of additional shares or other assets.
What Are The Advantages of Dividend Payments?
Tax Efficiency
Dividends are generally subject to lower income tax rates compared to salaries, making them an attractive option in terms of tax efficiency.
Flexibility
Dividends allow directors to choose the timing and amount of payments, providing greater flexibility in managing personal cash flow.
Multiple Shareholders
Dividends can be distributed among multiple shareholders, such as family members or spouses, allowing for income splitting and potentially reducing the overall tax burden.
What Are The Disadvantages of Dividend Payments?
No NICs
Unlike a director’s salary, dividends do not attract NICs, meaning directors may miss out on certain benefits like state pension contributions.
Mortgage and Loan Applications
Lenders may consider dividends as less reliable income, potentially affecting mortgage or loan applications.
Reduced Dividend Allowances
Recent cuts to dividend allowances mean that a larger portion of dividend income may be subject to higher tax rates, reducing the overall tax advantages.
How To Decide Whether a Director’s Salary or Dividend Payments Are Right For You?
When deciding between a director’s salary and dividends, directors must carefully evaluate their personal financial circumstances, taking into account the recent tax changes. While a director’s salary provides certain advantages such as NICs and pension contributions, it also incurs higher taxation and impacts tax liability.
On the other hand, dividends offer tax efficiency and flexibility but are not subject to NICs and may face reduced allowances. Seeking professional advice from a qualified and trusted accountancy firm, like ourselves, can help directors navigate these complexities. Our expert team of tax advisors will provide the exact resources to make well-informed decisions that align with your financial goals and the company’s interests.
We hope this has outlined to you what to consider if you’re deciding whether to take out a director’s salary or dividends. If you’d like to know any further information, or anything accounting related, please do not hesitate to get in contact with us at Nordens, where one of our trusted advisors would be happy to talk you through your query.
