One of the most common questions from limited company owners is how to pay themselves in the most tax-efficient way. The answer depends on your personal circumstances, your company's profitability, and how you want to structure your finances long term. This guide covers the main options and what you need to consider.

The Salary and Dividend Combination

The most common approach is to pay yourself a small salary up to the personal allowance of £12,570, and take the remainder as dividends. Dividends are taxed at 10.75% for basic rate taxpayers and 35.75% for higher rate, making this significantly more efficient than a pure salary. If you have income from other sources such as rental income or a second employment, your personal allowance may already be used elsewhere and a lower salary may be more appropriate.

If you are the sole director with no other employees, you cannot claim the Employment Allowance, meaning the company pays employer's National Insurance at 15% on salary above £5,000. On a £12,570 salary that is roughly £1,136 per year, still modest compared to the overall tax saving but worth including in your calculations.

Pension Contributions

Company pension contributions are a deductible business expense, reducing your corporation tax bill, and unlike salary or dividends there is no income tax or National Insurance on contributions paid directly from the company into your pension. The annual allowance is £60,000, and unused allowance from the previous three tax years can be carried forward, giving you the opportunity to make a larger contribution in a profitable year.

A Practical Example

Tom is the sole director of a profitable consultancy business. He pays himself a salary of £12,570 and takes £30,000 in dividends. His salary uses his personal allowance, so no income tax is due on it. The company pays £1,136 in employer's NI. His dividends fall within the basic rate band, so he pays 10.75% on £29,500 after the £500 dividend allowance. His total tax and NI position is significantly lower than if he had taken the same amount as salary.

Key Takeaways

• If you have income from other sources, the £12,570 salary may not be the most efficient starting point and your structure should be reviewed accordingly
• Sole directors cannot claim the Employment Allowance, so the company pays employer's NI on salary above £5,000
• Salary is deductible against corporation tax; dividends are not, so the interaction between the two affects your total tax bill across both the company and personally.
• Company pension contributions reduce corporation tax and attract no income tax or NI
• The right structure depends on your personal tax position and company profitability

How Traction Can Help

If you are not sure whether your current approach is the most efficient, or if your circumstances have changed, get in touch and we can walk you through the options.