Starting a limited company is often a sensible choice for self-employed workers, but it can present you with a lot of things to get your head around.
One of the differences between being paid by an employer and running your own business is having to sort out your own pay. You can do this by taking a salary from your limited company – in the same way as a regular employee.
Why take a salary?
There are two main reasons to take a salary from your limited company:
High or low salary – why would I want to take a low salary?
As a UK taxpayer in the 2019/20 tax year, you’ll have a personal allowance of £12,500 (increased from £11,850 for 2018/19). This means you can earn this much each year without paying income tax.
There’s also a National Insurance Contribution (NIC) threshold, but this is set at a slightly lower level before you pay anything to the government.
Under current rules, ‘office holders’ (ie. people who hold a position at a company but don’t have a contract, or receive regular salary payments) aren’t subject to the National Minimum Wage Regulations unless there‘s a contract of employment in place. A very low salary can be paid which means you do not pay NICs.
In the 2019/20 tax year, if your salary is above the NIC ‘Lower Earnings Limit’ (£6,136) but below the NIC ‘Primary Threshold’ (£8,632) you don’t pay NICs, but you do retain your State Pension contribution record. Win, win!
Note: The NIC Lower Earnings Limit for the 2018/19 tax year was £6,032 and the NIC Primary Threshold was £8,424.
High or low salary – why would I want to take a higher salary?
If your salary is too low, there are some disadvantages, such as:
- Reduced maternity benefits. Technically, to qualify for maternity benefits, you need to be “employed” and thus be compliant with the National Minimum Wage Regulations
- You could miss out on part of your annual tax-free personal allowance if your salary is paid at the NIC Primary threshold (ensure you understand the impact of the total amount of salary and dividends you take from your company and other sources of income on your available tax-free personal allowance)
- Reduced cover under permanent health, critical illness, personal accident or similar policies for which benefits are calculated by reference to earnings
- Issues with National Minimum Wage Regulations if you want to have a Contract of Employment
- When applying for a loan or a mortgage you may need to meet certain criteria which can be unsympathetic to a low salary. However, there can be ways around this if you use a specialist self-employed mortgage broker such as Crunch Mortgages. (for more about self-employed mortgages see our helpful guide.)
Paying yourself in dividends
If your company makes a profit, which it hopefully will, then you have two options available to you. You can either reinvest it into the company or take it out and pay shareholders by issuing a dividend.
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 a dividend. This can be a tax-efficient way to take money out of your company.
Through combining dividend payments with a salary, you can ensure that you’re at optimum tax efficiency. You can find out more about dividends in our “What are dividends and what taxes do I pay on them?” article.
Tax implications of taking a salary
As with regular full-time employees, all salaries will be subject to tax via Pay-as-you-earn (PAYE). With three separate PAYE ‘taxes’, the benefit of reducing your Corporation Tax liability by taking a higher salary can soon be outweighed.
Income tax is cumulative on all employment earnings during the tax year. For example, if you’ve already earned £10,000 from any employment in a given tax year, your personal tax-free allowance will be reduced by this amount.
You can check out our tax rates and thresholds article for more information on the income tax rates.
Employee National Insurance Contributions
Unlike Income Tax, employee National Insurance Contributions (NICs) aren’t cumulative. This means each new employment has a separate earnings threshold before NICs are due. For employees who are Higher Rate taxpayers, there’s a maximum amount of NICs to be paid.
If you’re an employee (but not a director), this threshold is set as a monthly amount. If you’re paid over this amount in any given month, you’ll have to pay NICs even if your pay for the rest of the year is reduced.
Directors have an annual threshold, which is 52 times the weekly threshold amount. When salary starts to go over this, they pay NICs.
We’ve got an article with all the tax and National Insurance thresholds and rates.
Employer National Insurance Contributions
The threshold for employer NICs works in the same way as employees. For every salary amount your employee earns above the weekly National Insurance earnings threshold, the employer has to pay NICs at 13.8%. This represents another PAYE tax the company has to pay.
Read more about current tax rates and thresholds
Putting it all together
Taking all the above taxes together, it’s usually tax-efficient for most people to take a salary up to the Primary National Insurance threshold (£8,632 in the 2019/20 tax year, or £8,424 in 2018/19).
As the Lower Earnings Limit is below the National Insurance Primary threshold, you’ll still accrue qualifying years for the state pension.
If you pay yourself a salary up to the National Insurance Primary threshold from your limited company, you won’t pay any Income Tax or National Insurance on it as long as it’s your only earnings. We usually recommend this option on the basis of tax efficiency. There may be reasons, as outlined above, why you may decide to pay yourself a higher salary. As a company director, you choose the amount of salary you are paid.
If you’re a Crunch client and wish to pay yourself a salary higher than the Primary National Insurance threshold amount, please contact your client managers.