How to Take the Most Tax-Efficient Director’s Salary in 2021/22
With the new tax year approaching, you may be wondering what’s the best way of taking a director’s salary in 2021/22.
As a director, taking a salary isn’t as simple as keeping your profits as sole traders do. It’s a bit more complicated than that, but we’re here to help.
This article contains:
- What is a director’s salary?
- The benefits of taking a director’s salary
- Salaries are an allowable expense
- You can avoid paying National Insurance twice
- What’s the most tax-efficient way to take a director’s salary?
- What if there are two or more directors?
- What about the rest of your income?
What is a director’s salary?
If you are new to being a director, a director’s salary is a method of paying yourself in the most tax-efficient way. Taking a regular salary is not the most tax-efficient way of paying yourself. It could leave you paying way more tax than you need to.
That’s why most company directors take a combination of a small salary and dividends.
The benefits of taking a director’s salary
Salaries are an allowable expense
Limited companies pay Corporation Tax on profits but you can reduce this amount by claiming allowable expenses. Salaries, either for yourself or employees, fall under this.
Therefore, by taking a director’s salary, this is an allowable expense that can help to lower your Corporation Tax bill.
You can avoid paying National Insurance twice
The way National Insurance (NI) works is that you must pay it as both an employer and an employee.
As a director, you are technically an employee. Therefore, if your salary exceeds the NI threshold, you will need to pay employee NI and the business must also pay employer NI. It’s just not very tax-efficient to pay National Insurance twice on the same income.
A tax-efficient director’s salary works around the NI thresholds, outlined below:
- Lower Earnings Limit: £6,240 per annum - Employees earning below this won’t pay NI, but also won’t receive NI benefits such as qualifying payments towards the State Pension.
- Primary Threshold: £9,568 per annum - This is when employees must pay NI. Anything between the Lower Earnings Limit and the Primary Threshold means you won’t pay NI, but you will still accrue NI benefits.
- Secondary Threshold: £8,840 per annum - Employers must pay NI at a rate of 13.8% of salary payments above this.
What’s the most tax-efficient way to take a director’s salary?
So what does this mean for taking a director’s salary in 2021/22?
The best director’s salary for sole directors is £8,840 per annum or £736.66 per month. The reasons for this are:
- It’s below the Secondary Threshold, so you won’t have to pay employers NI
- It’s below the Primary Threshold so you won’t need to pay employees NI
- It is above the Lower Earnings Limit, so you will still accrue NI benefits which count towards your State Pension
- It’s below the Personal Allowance threshold for Income Tax, which is currently £12,570
What if there are two or more directors?
If there are two or more directors on the payroll, this means they can claim the Employment Allowance.
The Employment Allowance allows companies to claim up to £4,000 to cover the costs of the employer’s National Insurance. However, to be eligible, the company needs at least two directors on the payroll which means sole directors can’t benefit from it.
With the Employment Allowance in place, the optimum salary for two or more directors is at the Primary Threshold of £9,568 per annum or £797.33 per month. Taking a salary at this amount means that the directors will be able to avoid paying National Insurance.
What about the rest of your income?
As a director, you probably aren’t going to want to take just £8 to £9k a year for yourself, so what about the rest of your income?
The rest of your income can be taken out as dividends. Dividends are payments made from the profits of a company to the shareholders. So, if you are a director and shareholder, you can pay yourself a dividend.
The Dividend Allowance is £2,000 before you need to pay any tax. This means you can take advantage of that and your Personal Allowance before you need to pay tax.