The most tax efficient way to pay yourself as a limited company director

As a company director, deciding how much you should pay yourself, as well as how to do so in a tax efficient manner, is crucial to being able to achieve your financial goals. Whether that’s extracting funds for your own personal use or retaining profits to invest in and grow your business, ensuring that you’re paying yourself tax-efficiently can make a big difference. We provide a comparison between taking a director’s salary and dividends, as well as consider how national insurance and employment allowance will factor into your decision making.

What is a director’s salary?

Directors are employees of the company they are running and therefore entitled to receive a salary for their work. Even where you’re the sole director and own 100% of the shares in your company, this still stands. Directors have a legal responsibility to perform and fulfil statutory duties such as ensuring your statutory accounts are filed and audited (where necessary), submit your company tax return, complete your confirmation statement, and carry out company secretarial duties where a secretary has not been appointed. As directorship is a significant role to undertake, you are able to decide on your own director’s salary that you believe to be fair and reasonable. However, you’ll also want to consider what is tax efficient which we’ll help you make a decision on based on various factors that may relate directly to your own situation.

How is a director’s salary taxed?

A director’s salary is treated as earnings and therefore subject to income tax. For the tax year 2024/25 the income tax rates are as follows:

• Earnings up to £12,570 – 0% income tax as this is your annual personal allowance and you can earn up to this amount tax free
• Earnings between £12,571 – £50,270 – 20% basic rate income tax
• Earnings between £50,271 – £125,140 – 40% higher rate income tax
• Earnings of £125,141 and over – 45% additional rate income tax (these earnings are fully subject to income tax as the personal allowance is removed at this point)

What are the advantages of taking a director’s salary?

There are many reasons why it is beneficial to take a director’s salary including:

• Enables you to receive regular income which can help provide financial stability and also improve your credit score for loan applications
• Utilises your personal allowances (for most income taxpayers with the exception of additional rate income taxpayers) as you cannot carry forward this allowance to the next year
• Can allow you to contribute towards your National Insurance (NI) contributions record which entitles you to receive the state pension
• Reduces your profits for corporation tax purposes and therefore reduces your company’s tax bill
• Receiving a salary makes up your net relevant earnings which determines how much pension contributions you can make without attracting tax charges

What are the disadvantages of taking a director’s salary?

Usually, it is recommended that you take a combination of salary and dividend as this will help offset some of the disadvantages that come with taking a director’s salary which include:

• Earnings from a director’s salary are charged at a higher rate of tax than dividends (this is explored in more detail below)
• The more salary one takes, the higher the NI contributions need to be made by both director and company (in the form of employer’s NI)
• Taking a salary is less flexible than taking dividends and requires running a payroll system

What are dividends?

Dividends are a discretionary distribution of company profits amongst its shareholders. If you’ve set up your own limited company then you’ll likely be both a company director and shareholder, therefore entitled to receive dividends. Unlike a director’s salary, dividends can only be issued where there are sufficient profits within the company to do so after business expenses and tax have been accounted for. Importantly, dividends are discretionary whereas a salary is obligatory.

What is the tax on dividends?

Dividends are still a form of income and follow the same income tax bands as salaries, however they benefit from their own specific rate of dividend tax as well as annual allowance. For the tax year 2024/25 the dividend tax rates are as follows:

• Dividends of up to £500 – 0% tax as this is the annual dividend allowance (you will not lose this allowance even where you are an additional rate taxpayer unlike with salaries).
• Dividends at the basic income tax rate – 8.75%
• Dividends at the higher income tax rate – 33.75%
• Dividends at the additional income tax rate – 39.35%

What are the advantages of taking dividends?

Some directors may choose to solely take out dividends, especially where they have just started a new business. This can often be due to feeling more comfortable in withdrawing funds from the business knowing it is operating in the black, but can also be down to the advantages:

• One of the major advantages of taking dividends is that they are charged at a lower tax rate than salaries
• Additionally, dividends do not attract NI for either the employee or the employer
• Dividends are much more flexible than salaries – there is no minimum or maximum limit to how much can be withdrawn so long as there are sufficient profits to do so and they can be taken as often as you like

What are the disadvantages of taking dividends?

Nevertheless, it’s still advisable to take a combination of dividends alongside a director’s salary because of the drawbacks:

• Dividends can only be taken when a company has sufficient profits to do so. If more dividends are taken out than there are profits then this could unintentionally convert into a director’s loan which has strict rules and potentially high tax charges. This also makes relying on dividends an unstable option as business profits are unlikely to remain consistent each year.
• For larger companies, dividends can only be issued where a majority of shareholders approve of the decision to distribute profits. Formal procedures need to be followed each time you withdraw dividends from the company.
• Relying solely on dividends will restrict your net relevant earnings and therefore limit the amount you can put into your pension pots.
• If you are solely taking dividends then you’ll likely have gaps in your NI record and may therefore limit the amount of state pension you’ll be eligible to receive (you could choose to make voluntary contributions to maintain your NI record)

So, how much should you pay yourself as a company director?

Truthfully, there is no right or wrong answer, but the main aim here is to be as tax -efficient as possible. To achieve this, key factors that we must consider are NI, the different NI thresholds, and the possibility of being eligible for employment allowance. The NI thresholds are due to change come April 2026, so we’ll cover both the 2024/25 and 2025/26 tax years.

1. Pay yourself at least the NIC Lower Earnings Limit (LEL)

For 2024/25 the LEL is £6,396. Paying yourself at least this amount means that, although you are not required to make NICs, you’ll still be treated as such on your NI record. This is important as you need 35 years of NICs to receive the full state pension (although you’ll still be able to receive a portion of the state pension if you have taken under this). What’s more, paying yourself £6,396 will mean you have no income tax to pay, no personal NI to pay, and no employer’s NI to pay from your company.

However, from April 2025 onward, the LEL will increase to £6,500. At the same time, the secondary threshold (which applies to employers i.e. your company) will reduce to £5,000. This means that if you pay yourself £6,500 you’ll have no income tax or NI to pay, but your company will need to pay £225 in employer’s NI.

2. Pay yourself at least the Primary Threshold

Currently, the primary threshold for 2024/25 is £12,570. If you decide to pay yourself this much, you’ll take full advantage of your personal allowance which means you won’t have any income tax to pay, and you can still benefit by not having to make NICs whilst still being recorded as such (paying yourself over this amount will mean you’ll have to start paying Class 1 NI).

However, this is over the secondary threshold which currently stands at £9,100. This means your company will have to pay employer’s NI of £480. Come April 2025, the secondary threshold is due to reduce to £5,000 and employer’s NI is due to increase from 13.8% to 15%. Your company’s NI liability will therefore increase to a total of £1,135 for the year.

3. Pay yourself a higher salary when you can claim employment allowance

If your company has more than one director, or one director and at least one employee, you’ll be eligible to claim employment allowance. In the tax year 2024/25, employment allowance is worth £5,000 and is offered as employer’s NI relief. If there are two people working in your company earning the same salary, you could both receive a salary of up to £27,200 with no employer’s NI to pay. However, you would each have income tax of £2,926 to pay as well as £1,170 to pay in employee’s NI.

Come the 2025/26 tax year, employment allowance is due to increase to £10,500 enabling you to pay yourself even higher salaries without your company incurring. employer’s NI. The highest salaries you would both be able to take would be £40,000 a year. This would result in £5,486 to be paid by each director for income tax and £2,194 in employee NI.

With all of the above options, it is important to bear in mind that any salaries and employer’s NI paid by the company are business expenses which are tax-deductible. This means that these costs will reduce your company’s corporation tax. Once you have paid your corporation tax, you can pay yourself dividends from the profits leftover as you wish.

Other ways to pay yourself through a limited company

Once your business is well established or you begin reaching the higher and additional income rate tax bands, you may want to consider other strategic avenues to withdraw funds from your company. By combining different methods of paying yourself through your company, you can both reduce your corporation tax and income tax liabilities. Read our article on 5 ways to take money out of a limited company for your own use to find out more.

Get help with your director’s salary

Whether you want help running your payroll for your director’s salary or need help completing your dividend voucher, our team are on hand and can offer the tailored support that you need. Use our online contact form to get in touch.