Deciding whether Dividends or a Salary are most beneficial to you
In the UK, there are two main options for earning money via a business. These two options are dividends and salaries. Shareholders of a company can receive dividends, whereas employees can be given a salary in exchange for their work and services. There are both advantages and disadvantages to dividends and salaries. Whichever combination you choose will depend on your circumstances as an individual.
Business owners usually use dividends as a way to pay themselves from the profits that their company makes. Dividends have an advantage over salaries as they are generally taxed at a lower rate. In April 2016, a dividends allowance was put in place in order to allow £2000 each year tax free via dividends. Anything over £2000 is still taxed at a lower rate than income tax. This is particularly beneficial to small business owners, as they can use this as a way to take money out of their business in a tax-efficient way.
If you’re a small business owner that wants to reinvest your profits in order to grow, dividends can be a lot more useful than a salary. Dividends can be paid to you from your business’s retained earnings. When paid out in this particular way, your business’s cashflow will not be affected nearly as much compared to paying out for a salary. This allows your business to reinvest in its own growth and development.
Depending on your situation, dividends may not be for you. Dividends will be paid out depending on how well your business is performing and how high profits are. So, dividends can vary from year to year, meaning that if no profits are made shareholders may not receive any dividends at all.
Unlike salaries, dividends are not counted towards your National Insurance contributions, which means they don’t provide the same benefits. This means that those only receiving dividends will not be contributing to your state pension credit each year. This is something you should keep in mind when deciding which path to take. Stability and a guaranteed income is an incredibly important thing to a lot of people across the UK.
Salaries provide stability as they are paid monthly, or even weekly. They also allow employees to receive benefits like pension schemes, maternity leave and sick pay for if or when they are unwell and are unable to work. This is something that shareholders, with no salary, will not be able to take advantage of.
As salaries provide a more stable source of income, it allows you to budget accordingly. You can plan your finances and your weekly or monthly budget because you will know exactly what you will be paid and when. This sort of insight can provide much more peace of mind, than the alternative.
National Insurance contributions will tax your salary, whereas they won’t for dividends. This means that employees will be taxed more overall compared to shareholders that only receive dividends as their source of income from the business.
If the company you work for states clearly in your contract that you may need to work overtime unpaid, this may mean that you could be working at a lower hourly rate on average, if this occurs often enough. However, your average hourly wage, legally, cannot go below the national minimum wage.
Which will you choose?
When it comes to choosing between salaries and dividends, it’s best to compare where each of them are lacking. Are dividend tax efficiencies more valuable to you than salaries’ stability and employee benefits?
It is also important to be aware that from April 2023, tax-free allowance for dividend income is reducing from £2,000 to £1,000 and then reducing again to £500 in April 2024.
To help plan and protect your income from these changes, you should consider altering your salary and dividend combination.
Use our Dividends Tax Calculator tool to find out how much you will be taxed for different circumstances, and find the best dividends and salary combinations for you! Or get in touch with the OutRise team to discuss which path is more beneficial for your growing business.