If you’re a major shareholder of a private company it’s usually a good idea to take a salary from your company because it’s efficient for tax and NI purposes. But that’s just one reason; there’s another with more long-term financial benefits, namely to earn credits towards your state pension, assuming you aren’t generating them elsewhere. After changes in the rules on taxation of dividends setting company directors salaries has become more complicated.
You can generate a pension credit at zero cost to you. All you need do is draw a salary of more than the NI lower earnings limit (LEL), which is £5,824 for 2016/17. You can pay this as a single amount or spread over the tax year.
It’s expected that a year’s credit will buy you about £225 at today’s value of state pension per year for life once you reach pension age. As already mentioned, it costs you nothing and as far as your company is concerned it’s an alternative to distributing profits to you in another way. If you already have 35 years of pension credits, you qualify for the full new single tier state pension, which applies to those reaching pension age on or after 1 April 2016. Drawing a salary above the LEL won’t improve this.
Taking a salary is more tax efficient than taking dividends up to a certain point. The rules changed for dividends changed on 6th April 2016 meaning that many people who previously paid no additional tax on dividends will pay at least 7.5%. The amount of tax you will pay on dividends will depend on the other income you have and what sort of income it is. But, as a rule of thumb, if you’re going to pay higher rate tax as a result of taking the salary, limit your wages to the tax free allowance.
Most trading companies qualify for the employment allowance (EA). This is a £3,000 reduction in their employers’ NI liability. This can come into play in deciding how much salary to pay yourself in 2016/17, but only if your company isn’t already using the EA in full against its NI bill due on other salaries. However, assuming it has used the EA, and you expect to be liable to higher rate tax, it’s still efficient to take a salary of up to £8,112, because until that point your company isn’t liable to employers’ NI on your pay.
Where your company hasn’t used the employment allowance against its NI bill on other salaries, and you won’t be liable to higher rate tax, you can push the salary up another notch, to the level of your personal tax-free allowance for 2016/17, i.e. £11,000. While this triggers an NI bill for both you and your company, the latter will be reduced to nil by the employment allowance. This tips the salary into the tax (and NI) efficient bracket.
To find the ideal rate of salary would involve a fair amount of guesswork about tax rates at this time of year. Therefore, a good strategy is to pay yourself up to the LEL in the first month or two of the tax year and then top it up to the most tax/NI efficient level in March 2017.
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