Running a limited company comes with many perks, but one of the biggest benefits is having full control over how you draw income from your business.
Many business owners default to paying themselves a standard salary, but is that actually the most tax-efficient route? At Gross Klein Wood Accountants Peterborough, we frequently work with director-shareholders to optimiSe their pay structures, ensuring they keep more of their hard-earned profits while staying fully compliant with HMRC.
Understanding how to balance salary and dividends is key to maximising your take-home pay.
Salary vs. Dividend: How Do They Differ?
To understand why a combined strategy works best, it helps to look at how these two income streams are treated for tax purposes:
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Director Salary: This is paid directly by your company and treated as an allowable business expense. This means it reduces your company’s profit, lowering your overall Corporation Tax bill. However, salaries above certain thresholds are subject to Income Tax as well as Employee and Employer National Insurance Contributions (NICs).
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Dividends: Dividends are payments made to shareholders out of the company’s after-tax profits. Because Corporation Tax has already been paid on these profits, dividends are exempt from National Insurance. Additionally, dividend tax rates are generally lower than standard Income Tax rates.
The Optimum Strategy: The Low Salary, High Dividend Approach
For most director-shareholders, taking a low salary combined with dividends offers the highest level of tax efficiency.
Why Take a Low Salary?
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Maintain National Insurance Credits: By setting your salary at the Primary Threshold for National Insurance, you avoid paying Employee or Employer NICs while still qualifying for your State Pension and benefit years.
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Reduce Corporation Tax: Your salary is a tax-deductible business expense for your limited company.
Why Top Up with Dividends?
Once your low salary is set, you can take remaining drawings as dividends. Because dividends don’t attract National Insurance, drawing income this way is typically much cheaper than taking a high salary.
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The Tax-Free Personal Allowance: Everyone has a tax-free Personal Allowance (£12,570), which can be covered by your low salary.
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The Dividend Allowance: You also receive a tax-free Dividend Allowance (£500). Any dividends drawn above this threshold are taxed based on your personal Income Tax band.
Important Factors to Keep in Mind
While the low-salary/high-dividend route is very popular, it isn’t one-size-fits-all. When designing your remuneration plan, the team at Gross Klein Wood Accountants Peterborough always considers a few critical factors:
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Company Profitability: Dividends can only legally be paid out of retained earnings (profit after tax). If your company hasn’t made a profit, taking dividends is illegal (known as an unlawful dividend).
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Multiple Directors or Shareholders: Dividend distributions must match share ownership proportions unless you have different share classes set up.
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Mortgage & Loan Applications: Some mortgage lenders prefer seeing higher salary income rather than dividend drawings, though many modern lenders are comfortable with director dividends.
Get Tailored Advice from Gross Klein Wood Accountants Peterborough
Tax rules and allowances shift regularly, meaning what was optimal last year might not be the most tax-efficient structure today.
At Gross Klein Wood Accountants Peterborough, we help limited company directors set up tailored tax planning strategies that protect their wealth and support their long-term financial goals.
Are you sure your current pay structure is working as hard as it should be? Contact Gross Klein Wood Accountants Peterborough today to review your director remuneration and ensure you aren’t paying a penny more in tax than necessary.
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