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How to save money by paying yourself

What is the best way to take money out of my business?

If you are a profitable, Owner Managed Business (OMB), what’s the most tax effective method of withdrawing cash from your firm?  Assuming you have a limited company (sole traders have little room for manoeuvre), the answer always lies in considering the tax impacts. Both in the company making the payment and in the hands of the owner receiving the money.

Special cases: Director Loans,  Accumulated Reserves and other small savings

First there are a few special, highly tax effective special cases.  Any director loans injected into the business to fund its early start-up and growth phases can and should be repaid first since no tax is payable by either party.  Next, if you have accumulated reserves, a large portion of these can be paid as dividends with tax only paid by the owner on receipt.

There are a number of relatively small expenditures which simultaneously reduce corporation tax in the company yet can be received by employees or owners free of any personal tax liability.  Although important, because of their tax efficiency, most of these will not transfer significant amounts of cash to owners and will therefore be outlined in a later blog.

Finally, if owners wish to exit their businesses in the short term, a sale process can yield additional tax savings since capital gains are taxed at half the rate of income. We do not consider this option further here as it’s a special one-off event.

Since, long term, companies cannot effectively transfer cash to directors via loans this leaves a basic choice between salary and dividends.

Should you pay a Salary or pay Dividends

From the company perspective, salaries are tax deductible whilst dividends aren’t (19% advantage for the former in 2017/18), but in the hands of a tax paying employee/director the latter are taxed at a lower rate (advantage 7-12%).  Unfortunately, National Insurance – payable both by employers and employees (worst case 26%) – mostly removes the apparent overall advantage from salaries.

In optimizing the trade-offs, we always look to retain the same amount of retained earnings and cash in the business and then calculate which option leaves the most after-tax cash in the hands of the owner.

The optimal solution in the Salary or Dividends debate

  • Pay is always better than dividends up to the point at which NI is payable (£8k)
  • This can be increased up to £11k in the absence of other employees to take advantage of the employers NI annual allowance
  • All other cash should be paid in the form of dividends
  • To put this in context, an owner paying himself an £11k salary plus £24k dividend would receive an extra £3k in after tax cash or 10% more than if he had paid himself exclusively via a salary of £40k (despite leaving the company in exactly the same position)
  • Whilst the presence of income from other sources will reduce overall benefits, this optimal allocation between salary and dividends remains unaltered

But marginal tax rates spike – beware of these limits

Due to the peculiarities of the UK tax system, there are certain levels of income where the marginal tax rates spike (up to 60% or more).  If you are claiming child tax benefit, then income of more than £50k triggers additional tax, whilst income above £100k starts to reduce the personal allowance.  These need to be avoided where possible.


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