If you’re self-employed and operating through a limited company, one of the key financial decisions you’ll face is how to extract money from your business. The two main options are salary and dividends. While both have their place, understanding the benefits of dividends can be a game-changer for your bottom line.
Dividends are essentially a share of the company’s profits distributed to shareholders. As a director and shareholder in your own company, you can receive dividends, which offers a number of tax advantages, the most significant of which is you avoid paying both employee and employer National Insurance Contributions.
Up to a certain amount, dividends are tax-free, and while the allowance has been reduced in recent years, it still provides a tax-free buffer and the tax on dividends in higher earnings is still lower than the normal personal tax rate. The allowance for the 2023/24 tax year stands at
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- Dividends up to £1,000: Tax-free
- Dividends between £1,000 and £50,270: Taxed at 8.75%
- Dividends between £50,271 and £125,140: Taxed at 32.7%
- Dividends over £125,140: Taxed at 38.1%
There’s other benefits too:
- Flexibility: Dividends are typically paid at the discretion of the directors. This offers more flexibility in managing your income compared to a fixed salary.
- Business Growth: By retaining profits within the company, you can reinvest for growth, potentially leading to higher future dividends.
- Pension Contributions: While you won’t pay NICs for pension contributions as an employee, you can make personal pension contributions as a shareholder.:
But, and there’s always a ‘but’, there’s considerations to bear in mind
- Company Profitability: Dividends can only be paid from profits. If your company isn’t profitable, you can’t pay yourself dividends.
- Corporation Tax: Your company still pays corporation tax on its profits before dividends are distributed.
- Dividend Restrictions: There are rules around when and how dividends can be paid. Talk to us to make sure you comply with those regulations
- Salary vs. Dividends: A balance between salary and dividends might be optimal. A small salary can maintain your National Insurance contributions for benefits like State Pension and Statutory Sick Pay.
Paying yourself dividends can be a powerful tool for tax efficiency if you’re self-employed and running a limited company. However, it’s not a one-size-fits-all solution. Carefully weigh the benefits against the potential drawbacks, and chat to us to determine the best approach and how it fits your wider business and financial strategies.
