Guide to Paying Yourself

How should you pay yourself as a small business owner?

Effective fiscal management and establishing the best way to pay yourself are crucial aspects of success for self-employed people. Unlike employees receiving a monthly salary from their employer, self-employed people have significantly more control in terms of how they structure their remuneration. This presents an opportunity to leverage tax-efficiencies.

This guide covers the key factors you should consider when choosing how to pay yourself as a business owner.

Have a Business Bank Account

If you operate through a limited company, you’ll already have a business bank account as they’re a legal requirement for limited companies. If you operate as a sole trader, there are many benefits of opening a business bank account such as Mettle, the free business bank account by NatWest.

Although it may seem easier to use your personal bank account, separating your business and personal finances gives clarity and makes it far easier to track your income, expenses, personal withdrawals, calculate your taxes and manage cash flow.

Choose The Right Payment Method

There are various ways for self-employed people to pay themselves depending on their business structure including salary, dividends and owner’s draw. There are different tax implications for each payment method and it’s important to understand the differences between them.

Limited Company Salary & Dividends

If you operate through a limited company, you may be able to split your remuneration between a combination of salary and dividends.

If you work outside IR35, you’re free to choose the level of salary you take from your company. Generally, the most tax-efficient salary is the tax-free personal allowance – £12,570 for the 2023/24 tax year. This amount is at the Employees National Insurance threshold which means income tax and National Insurance Contributions are at a tax-efficient level and the salary is considered a deductible expense for Corporation Tax purposes. Any business expenses that are paid personally should go through the company to attract Corporation Tax.

You can then supplement your income by paying yourself dividends. Dividends are taken from company profits after Corporation Tax, salary and expenses are taken into account. Dividends are taxed at a lower rate than income tax rates on a salary and aren’t subject to National Insurance Contributions, meaning that if you structure your remuneration in a tax-efficient manner, significant tax savings can be made.

Dividend payments can be made as frequently as you like but they are usually paid quarterly. The tax you pay on the dividends you receive is calculated from your self-assessment tax return.

when to set up as a sole trader

Sole Trader Drawings

From a legal perspective, a sole trader and their business are the same legal entity which means they have complete control over their business finances. Sole traders are able to take drawings which is withdrawing money from their business for personal use.

Drawings are considered a flexible and simple way of paying yourself but it’s vital that owners drawings are tracked to ensure accurate tax and financial reporting.

National Insurance Contributions and income tax aren’t automatically deducted from the drawings. The overall profits of the business are then taxed on the individual as self-employed profits subject to income tax and National Insurance.

It’s important to strike a balance between withdrawing funds for personal use and leaving enough cash in the business to keep it running.

Prepare for Income Variance

Self-employed people such as contractors can experience fluctuations in their income due to project-based work. Depending on your sector, seasonal variation can also affect income levels. It’s important to budget effectively and retain enough funds in your business to cope with lean periods.

Budget for your Tax Obligations

As a self-employed person you have the responsibility of calculating your tax liability including National Insurance Contributions and income tax. It’s sensible to set aside some of your income into a dedicated separate savings account so you have funds in place to meet your tax obligations.

Regularly Review your Business Finances

It’s important to monitor and regularly review your business finances and payment strategy to keep a handle on the overall financial health of your business. Are you taking too much in owner’s draws? If so, you should adjust your payment strategy. Accounting software such as FreeAgent can give you an at-a-glance overview of your business’ financial position.

Maintain an Emergency Fund

Maintaining an emergency fund gives you a financial safety net to cover any unexpected expenses or events. The financial security this provides will give you peace of mind knowing that funds are in place to make your business financially resilient.

Plan for the Future

As well as optimising how you pay yourself now, you should plan ahead and make pension contributions so you can pay yourself from a pension after you retire. Funds can be allocated to a pension for retirement planning purposes as well as into personal savings such as an Individual Savings Account to secure your financial future.

Work with an Accountant

When you appoint an accountant, they will be able to provide expert advice and guidance on the best and most tax-efficient way to pay yourself. In addition, all your accounting needs will be taken care of including self-assessment, corporation tax and VAT returns and much more. If you’d like advice on paying yourself or have any queries about our service, please request a call back here or call 0330 024 0406 to speak to an accountant.

How can Gorilla Accounting Help?

With the increased administrative responsibilities that limited companies have, you may find yourself paying more money in accountancy fees.

If you would like more information on choosing the right option for you, please get in touch as soon as possible.

At Gorilla Accounting, we ensure you only pay one set fee which includes no extra charges. You’ll also receive full guidance from your accountant should you struggle with any aspect of running your own limited company.

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