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One of the main advantages of running a limited company is the flexibility in how you pay yourself as a director. Unlike employees, who are typically paid entirely through Pay As You Earn (PAYE), directors can take a combination of salary (processed through PAYE) and dividends. This allows you to structure your income in a way that can be more tax-efficient, while also giving you greater control over when and how much you take from the business.
However, it can be challenging to stay compliant and some directors don’t structure their remuneration as tax-efficiently as they could, meaning they fail to maximise the financial benefits of operating through a limited company and can pay more tax than necessary
Understanding how to pay yourself correctly, as well as having strategies in place to maximise tax-efficiency, are key aspects of being a director. By getting the right accountant support, directors can structure their income efficiently, remain compliant with HMRC regulations and ultimately take home more of their earnings.
The Impact of the Limited Company Business Structure
When you operate through your own limited company, perhaps as an owner-director, the way you extract funds from your business is different to sole traders. For sole traders there is no formal payroll or dividend system – you can simply withdraw funds from your business as and when you need them, known as owner’s drawings.
For limited companies, the owner and the business itself are separate legal entities which means any funds taken from the business must be recorded properly and taxed correctly.
Not managing your director withdrawals properly can result in:
- Unexpected tax liabilities
- HMRC enquiries, penalties or interest charges
- Reduced tax-efficiency
- Inaccurate financial records and reporting
- Issues with cash flow
This underscores the importance of having a clear and compliant remuneration strategy.
How Can Directors Pay Themselves?
Limited company directors have several ways to take income, and it’s important to understand how each method affects tax, cash flow, and compliance as well as tax-efficiency.
Salary
If you take a director’s salary, tax is deducted at source through PAYE in the same way it is for employees, which means payroll has to be processed.
Many directors choose to take a relatively low salary, often at the £12,570 personal allowance threshold, which can:
- Help to minimise overall tax and National Insurance liabilities
- Maintain State Pension entitlement
- Be treated as a deductible expense to reduce the company’s taxable profit
The most tax-efficient salary level depends on a number of factors including your personal circumstances, tax thresholds and applicable National Insurance and income tax rules.
Dividends
Dividends can be one of the most tax-efficient ways to extract profits from a limited company and one of the key reasons the limited company business structure is so popular.
A dividend is a distribution of retained company profits paid to shareholders after Corporation Tax has been accounted for as a return on their shareholding in the business.
- Dividends have their own tax rates which are lower than income tax on salary
- Dividends are not subject to NICs
- They give directors much greater flexibility over how income is taken
Due to the dividend tax rates being lower than the income tax rates, many directors choose to pay dividends to supplement their salary, and thanks to the dividend allowance the first £500 is tax-free.
To remain compliant, you can only issue dividends when the company has sufficient retained profit. There are formalities to follow and dividends must be properly documented, accurately recorded and reported on your self-assessment.
Director’s Loans
Directors can take funds from their company temporarily through a director’s loan which is recorded through a director’s loan account. Director’s loans can be used to solve personal cash flow issues or in instances where a decision to declare dividends or salary has not yet been paid and funds are needed.
It’s important to manage this correctly or director’s loans can trigger additional tax charges and compliance issues if the loan becomes overdrawn and it is not repaid on time, or if withdrawals are not recorded and reported as per HMRC rules.
How Accountants Help Directors Pay Themselves
The support an accountant provides is much more than just completing annual tax returns. A key part of their role is to implement an overarching remuneration strategy that maximises tax-efficiency as well as ensuring all processes are followed, so you remain compliant with HMRC regulations while reducing your tax liability.
They Ensure You Follow the Correct Process When Taking Income
Beyond strategic advice and tax planning, an accountant will help to manage the actual process of paying yourself from a limited company.
They run payroll using accounting software such as FreeAgent or Xero, calculate PAYE and submit RTI filings to HMRC to ensure salaries are paid compliantly with correct pay slips.
An accountant can also monitor director’s loan accounts to track balances and prevent tax charges or compliance issues. Having this expert support and using accounting software streamlines the process of paying yourself as well as ensuing compliance.
Advice on Income Structuring
A key part of an accountant’s role is to help directors structure the funds taken from their limited company in the most tax-efficient way possible. They will advise you on the most tax-efficient way to balance salary and dividends to minimise tax your liability, which includes:
- Determining the optimal salary level to maximise the benefit of the personal allowance
- Withdrawing the most tax-efficient amount of dividends
- Avoiding exposure to higher tax thresholds
Through ongoing strategic tax planning, accountants help directors retain more of their earnings while remaining fully compliant with HMRC rules.
Claiming All Allowable Expenses
An accountant will help to further reduce your tax bill by ensuring all allowable expenses are claimed. Allowable expenses are costs incurred wholly and exclusively for the purposes of running your business that are deducted from your taxable profit to lower your tax bill, such as:
- Mobile phone and internet costs
- Professional fees
- Subscriptions
- Business mileage costs
- Marketing and advertising
- IT equipment and software
It can be easy for directors to miss some allowable expenses but with an accountant in your corner you can be sure they are all claimed so you’re not paying more tax than you need to.
Pension Contributions
Pension contributions can also form a key part of a tax-efficient remuneration strategy and this is something an accountant can provide valuable advice on.
Employer pension contributions made by the limited company are usually:
- More tax-efficient than taking additional salary: Pension contributions avoid income tax and aren’t subject to National Insurance, unlike salary, meaning they are a more tax-efficient way to extract funds while building retirement savings.
- Corporation Tax deductible: Company pension contributions are treated as an allowable business expense and deducted from profits before Corporation Tax is calculated, reducing overall tax liability.
With the right accountancy support, pension contributions can be integrated into a wider strategy to improve tax-efficiency and build security for retirement.
Timing Income for Tax-Efficiency
The timing of your income can have a huge impact on the amount of tax you pay and an accountant will advise when to pay salary, dividends and pension contributions, as well as how much, to ensure your tax position is optimised.
Strategies include:
- Bringing Income Forward: Taking salary or dividends earlier can reduce your tax liability if threshold increases are imminent.
- Deferring Dividends: Delaying dividend payments into a different tax year can help keep income within lower tax bands and make use of unused allowances.
- Splitting Dividend Payments: Spreading dividends over multiple tax years helps smooth income and prevent cash flow issues and can reduce exposure to higher tax rates.
- Pension Contributions: The correct timing of pension contributions ensures that annual allowances and reliefs are maximised.
Our Accountancy Service
It can be challenging as a limited company director to ensure compliance and that you’re paying yourself in the most tax-efficient way possible to maximise the benefits of operating through your own limited company. The support of an accountant can be invaluable and tax optimisation is a key part of our accountancy service.
We take a proactive approach with your own dedicated accountant expertly managing all your business and personal accounting needs, including advising on tax optimisation strategies to ensure you are paid in the most tax-efficient way possible whilst remaining compliant with all HMRC obligations.
MTD-compliant FreeAgent or Xero accounting software is included saving you up to £330 a year and our client service guarantee means you’ll receive a same working day response to queries submitted before 3pm or we’ll issue you a £50 payment.
Get in touch today to speak to an accountant or get an instant online quote.
