As a business owner, you’re hard working and invested in your business, so it’s only right that you are remunerated accordingly.
To do so, most directors of limited companies pay themselves in some combination of salary and dividends. They may occasionally supplement this with pension contributions from the company as well.
Whilst these methods are effective and well-practiced, one cannot deny that certain drawbacks arise with each method. Let’s look at them in a little bit more detail.
First up: Salaries
One of the most common forms of remuneration is to pay yourself a salary. This is a popular method given that, even if your company makes no profit, you will still be able to take a salary. Furthermore, by taking a salary, you can acquire qualifying years towards your state pension and make higher personal pension contributions. In a similar vein, it enables you to receive maternity benefits if you were to fall pregnant and it can assist in the application for a mortgage.
The benefits don’t stop there either. By taking a salary, you can reduce the amount of corporation tax that your company pays.
It sounds pretty peachy, doesn’t it?
Well, unfortunately, there are certain drawbacks. For example, taking a salary means that both you and the company have to pay National Insurance Contributions (NICs). Furthermore, salaries can attract high rates of income tax. This means that the amount of capital you acquire will be less.
If you decide to take a salary, therefore, you need to work out how much you are going to take.
Here are some points that are worth considering in accordance with data for the tax year 2021/2022:
- To make national insurance contributions to your state pension, your salary needs to be at least £9,569.
- To not acquire an income tax, your salary must be covered by your personal allowance and sit below £12,570.
- A tax rate of 20% applies to income between £12,570 and £50,270. This increases to 40% on income between £50,270 and £150,000.
The second way in which many directors pay themselves is via dividends.
If your limited company has made a profit after paying corporation tax, it is possible to administer this profit to the shareholder of the company via dividend payments.
The advantage of this method is that there are no NICs payable on dividends.
However, as dividends can only be paid out of profits, relying too greatly on them may make your income unpredictable. Furthermore, unless you are eligible for the tax-free dividend allowance, you will need to pay tax on your dividend.
According to data from the tax year 2021/2022, you do not have to pay any tax on your first £2,000 of dividend income each tax year.
Furthermore, as the Personal Allowance for the 2021/2022 tax year is £12,570, if your total salary and dividend income were to fall below this amount, no income tax would be due. If you were to combine your Personal and Dividend Allowance, you could receive up to £14,570 income without needing to pay income tax. For a combined salary and dividend income that exceeded the latter figure, tax would need to be paid.
The third way in which directors may be remunerated is by taking pension contributions directly from their company.
This is advantageous in the fact that employer pension contributions do not add to your income and thus do not increase your tax bill. What is more, no limitations are incurred by the size of your salary. The only limitation placed on employer pensions is the annual allowance.
Unfortunately, however, there is one major drawback to this third method: you can’t access your pension until at least the age of 55.
As we have explored, therefore, each method of remuneration brings with it certain disadvantages, whether that be an increased tax bill, an unreliable dividend scheme, or an extended wait to reap the rewards of your hard work.
At rebuildingsociety.com we can offer you a fourth method of remuneration. One that is tax-efficient, reliable, and where your earnings are easily accessible.
The answer is our Director’s Loan Account Innovative Finance ISA.
With an IFISA account, you can lend to your business on our FCA-authorised peer-to-business lending platform, with all the benefits afforded to you under the ISA tax wrapper.
You can choose how much to lend, from £10 up to the annual allowance which currently sits at £20,000 and choose the interest rate your business pays (this should be commercially considered). Your company makes monthly repayments to you as either interest-only or capital with interest.
In many businesses, directors do not charge interest on their director's loan accounts, and often these have erratic repayments and informal arrangements. Formalising the loan and using an ISA wrapper changes this, making your investments work as hard as you do.
Case Study: £20K ISA at 18% pa
Catherine had never used an ISA before, always preferring to invest in her own business. Opening a Director's Loan Account IFISA and loaning funds to her company through the ISA allowed her to grow her business and supplement her income at the same time.
➜ Year 1 net interest earnings of £2 900
➜ Combined tax savings of £2 124
➜ Net gains total £1 424 for a return of 7.1%
- Interest earnings calculated as 18% of £20K minus fees: £3 600 - £699.88 = £2 900.12
- Fees for an interest-only loan are 13.33% of each interest payment
- The company reduces its Corporation Tax by £684 @19% and she saved £1 440 in Income/Dividend Tax @40% for a combined tax savings of £2 124
- Net gains calculated as tax savings minus fees: £2 124 - £699.88 = £1 424.12
- Net return % is £1 424.12 net gain / £20 000 invested = 7.1%
- 18% is the average interest rate, however this may be higher or lower
- Find out more in our FAQs
