As a new business owner, handling the finances of your business can be the most challenging thing. Even if you have an accountant, you are the one who needs to make the decisions regarding how to distribute your business’s finances. Your accountant can give you information on the tax-free thresholds and the most tax-efficient ways to pay yourself, but not what amount you should pay yourself. In this article, we will look at different ways you can pay yourself as a business owner and what factors you should consider.
Should I Pay Myself When Starting a New Business?
New business owners may be reluctant to pay themselves, thinking it is best to keep the profits in the company to boost growth. While you definitely want to keep as much profit in your business as possible so you can invest in people, equipment, and advertising to grow your business, you do not want to pay yourself nothing. The reasons you should take a company director’s wage are:
- You need to afford to live
- You deserve reimbursement for your time and expertise
- Investors or creditors will have an accurate picture of business expenses, including your wage
Even if you are starting a business while working a part-time or full-time job (such as a side hustle or an e-commerce store), you should pay yourself something.
How Can I Pay Myself As a Business Owner?
The way you pay yourself as a business owner and the tax implications of different methods will depend on your business entity.
How to Pay Myself As a Sole Trader
As a sole trader, your business and you are the same thing in the eyes of the law. This means that your business is taxed through your Self-Assessment Tax Return.
Someone who is self-employed will take money from their business through a process called “drawing.” They can take as much or as little as they wish as long as it is from profit only. You will need to calculate your tax liability and how much you need to pay for expenses and National Insurance before you take a drawing.
How to Pay Myself As a Business Owner – LTD
If your business is registered as an LTD, then you and your business are treated separately for tax and legal purposes. There are 2 main ways a business owner will pay themselves if their business is an LTD:
- Salary – Just like when you were an employee, you pay yourself a set weekly or monthly amount.
- Dividends – You take a cut of the profits on a regular basis.
There are other ways such as bonuses, stock payments, or even payment deferral agreements, but they can be complex, and we recommend speaking to your accountant for current information.
This article focuses largely on how to pay yourself for LTD business owners, so we will look at these ways of paying yourself further on in this article.
Director’s Salary
A director’s salary is a set yearly wage that you pay yourself as the business owner. You are essentially on the payroll of your company and will receive a set amount during each pay period. It is beneficial to pay yourself a salary as a business owner as it means you have a consistent income stream that allows you to plan a budget. Some financial institutions and credit check agencies will only take into account base salary when looking at personal finances for renting and buying property and cars. So, if you don’t take a salary, you may struggle with these activities.
What Salary Should I Pay Myself As a Business Owner?
That is a good question. We cannot give a set amount as it will vary depending on your personal and business circumstances. The most important thing to take into consideration is how much do you need to afford basic living costs? This is closely followed by how much can you afford while your business breaks even?
When calculating your director’s salary, you need to factor in personal considerations, and the impact decisions will have on your business. There is no point in putting yourself into massive debt or making yourself homeless in order to keep as much profit in the business as possible. Similarly, it is not a good look to fail to pay vendors, employees, and taxes because you want to live a lavish lifestyle (in fact, it is illegal).
Personal considerations when setting a director’s salary include:
- Living expenses
- Retirement contributions
- National insurance contributions
- Personal taxes
It is particularly important to note the different National Insurance thresholds to pay on your salary. You need to earn over a certain amount to stay in the National Insurance program (and therefore be eligible for unemployment benefits and state pension, among other things). But you can also approach your salary in a smart way to ensure you stay within certain thresholds to minimise how much National Insurance you pay, both as an individual and a company.
If you have an accountant, you should ask for a consultation to help you calculate and set up payroll to ensure it is done correctly.
Dividends
Dividends are paid on the total profit a company makes after taxes and business expenses. While dividends can be paid as often as you wish, most small business owners will pay them once a year after they have done their taxes. This ensures they are done accurately as overpaying dividends can result in hefty penalties from HMRC.
From a personal tax perspective, dividends are a really tax-efficient way to earn money from your business. As of 2021, there is a tax-free threshold of £2000 and dividend earning of up to £50,000 are only taxed at a rate of 7.5%. Salaried earnings are taxed at 20% or more.
From a business perspective, it allows you to ensure all your expenses and taxes are taken care of before giving yourself a little bonus. It also gives you time to consider how much of the profit you want to reinvest in the company and how much you want to allocate to dividend payments. If you are the sole company owner, you will receive 100% of the dividend amount. If there are multiple owners, the dividend amount will be distributed as per the percentage of ownership.
For example, your small business has made a profit of £40,000 once all business expenses, VAT, and taxes are accounted for. You decide that you want to reinvest half of that in the business and then issue the other half as dividends. So, there is £20,000 available to be issued as dividends.
If you are the sole business owner, you will get the entire £20,000 as a dividend.
If your business has 4 owners with equal shares, you will receive 25% of that as a dividend payment, so £5,000.
How to Pay a Dividend
In order to pay a dividend, you need to hold a director’s meeting, yes, even if you are the only director of the company. You will need to write up the minutes of the director’s meeting so you can submit proof of the process to the HMRC.
When paying someone a dividend, you must issue a dividend voucher. Think of it like a receipt showing that the payment is a dividend. The dividend voucher must provide the following information:
- The company name
- Date of dividend payment
- The name of all shareholders receiving a dividend payment
- The full dividend amount
Your accountant will be able to help you with the dividend voucher. Keep a copy of the dividend voucher for your company records and a copy for your personal tax records.
Can I Pay Myself a Combination of Salary and Dividends?
Yes, most business owners will pay themselves a director’s salary and take a dividend when their company has made a profit. Paying yourself a combination of a salary and a dividend means you can pay yourself in the most tax-efficient way possible.