So, you’ve set up a limited company and heard on the grapevine that dividends are an incredibly tax efficient way of rewarding yourself for your hard graft. The question is: how do dividends work?
If your company makes a profit, which it hopefully will, then you have two options for what you can do with it. You can either reinvest it into the company, or take it out of the company and pay the shareholders. This payment is called the dividend payment.
“But what is a shareholder?” The term shareholder simply refers to the owner(s) of the company. So, if you own and manage your limited company you can pay yourself via a dividend. This can be a particularly tax efficient method of self-payment.
One of the main advantages of paying yourself in dividends is that you can avoid National Insurance contributions. In fact, you can pay yourself free of tax as long as it doesn’t exceed the Income Tax limit of £43,875.
However, as tempting as it may be to take all the profits out of your company and pay for a jet setting holiday in Barbados, reinvestment has to be the priority. Sure, you need to pay yourself enough money to get by, but getting carried away can be fatal to your business.
Through combining dividend payments with a salary you can ensure that you’re at optimum tax efficiency.
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