One of the most common queries that we receive here at Handpicked Accountants is related to how much you should be paying yourself as a new business owner. The idea of starting your own business, being your own boss and being able to set your own salary might sound like heaven, but finding a sensible and realistic salary for yourself can be much harder than it sounds.
There are a number of factors to take into consideration when thinking about setting your own salary; firstly how much should your final take home figure actually be, and secondly what are the tax implications for this?
How Much Should You Pay Yourself?
In general there are three schools of thought concerning what your salary, as a new business owner, should be and it’s up to you which of these you choose. However it is worth remembering that most successful businesses are founded on sensible decisions that are made with the business’ best interest at heart.
Option 1: Pay Yourself What You Need
Especially in the start-up stage of any business you are unlikely to be actually turning a profit, so awarding yourself a large salary could put extra and unnecessary pressure on your business in its most delicate phase. Therefore many new business owners choose to pay themselves only a basic salary, enough to just cover their personal costs. To do this you will first need to make a realistic list of your monthly outgoings e.g. mortgage/rent, utilities, groceries etc., and it may also be worth adding a 10% contingency for those unexpected expenses. Once you have this figure then you can set your salary so that your take home pay will just cover these costs. It may then be that in time as your business grows you will be able to increase your salary.
Option 2: Pay Yourself What You’re Worth
Another option is to set your salary at a fair market rate for the work that you are actually doing. This may sound difficult to calculate but you can often get an idea by looking at other similar businesses and/or job roles and finding out how much they get paid. Often recruiters and job sites can be a good source of this kind of information, as can local networking, however make sure that you approach the subject tactfully.
Option 3: Pay Yourself in The Most Tax Efficient Way
We will elaborate on this point further a little later on, but once you have found a figure that you are happy with as your salary, it might be worth looking at the tax implications of paying yourself this amount. For example paying yourself a high salary may mean that you are also paying out a large amount of money through the PAYE tax scheme which could otherwise have been reinvested into the business.
Should You Pay Yourself At All?
This is a question that many new business owners ask themselves, especially in the first few months of trading when it is likely that the business will be running at a loss. Not paying yourself at all may seem like you are doing the best thing for your business, however bear in mind that not including your salary in the accounts may skew these if you are looking for future investment.
However, there are some times when it may be wise not to pay yourself. For example if the business isn’t doing too well and you are going to struggle to pay any employees, or settle any accounts with creditors, then talking a salary for yourself above these things may be frowned upon.
How Can You Pay Yourself In The Most Tax Efficient Way?
There are a number of options for paying yourself a salary from your business, but some are significantly more tax efficient than others.
Paying Yourself A Salary
If you choose to pay yourself entirely through a regular salary then you will have to pay tax and national insurance contributions based on the income tax band that you fall into.
For 2019/20 the personal allowance (i.e. the amount that you are allowed to earn without paying income tax) is £12,500. After that you will pay:
- 20% tax on earnings between £12,501 - £50,000 (basic rate)
- 40% tax on earnings between £50,001 - £150,000 (higher rate)
- 45% on any earnings over £150,000 (additional rate)
This will be collected through the PAYE (Pay As You Earn) scheme that is operated by HMRC. This is often a nice simple way of paying yourself a salary, however it is not always the most tax efficient. Please note that income tax is slightly different if you live in Scotland – find out more here.
As well as income tax, you will also be required to make National Insurance Contributions (NICs). NICs must be paid on any income over £8,632 annually. Companies are also liable to pay employer’s National Insurance on the salary taken by its employees, including the salaries of its directors.
It is easy to see why many directors turn to more tax-efficient methods to extract funds from their company rather than putting it all through the payroll.
Paying Yourself A Combination Of Salary And Dividends
The main aim of this approach is to increase the amount of money that you actually take home from your business every month (or however often you decide to pay yourself). The trick is paying yourself a small enough salary so that it falls both within your tax free personal allowance and you don’t have to pay employee or employer national insurance contributions. This salary can then be topped up with dividends that are taken from the company’s profits.
For 2019/20 the national insurance contributions threshold sits at £166 per week, or £8,632 per annum. This figure is also, of course, below most people’s personal tax allowance so you will not be liable for any deductions from this amount.
Individuals are also given an annual dividend allowance of £2,000 meaning dividends can be taken up to this amount free from tax. After that dividends are taxed according to your total earnings, taking into account your salary, but at a lower rate than PAYE tax. So if your total earnings are:
- between £12,501 - £50,000 you will pay 7.5% tax on your dividends over £2,000
- between £50,001 - £150,000 you will pay 32.5% tax on your dividends
- over £150,000 you will pay 38.1% tax on your dividends.
As you can see, following this approach will mean that you are only paying tax on your total earnings above £13,164 per annum, and then at a much lower rate, especially if you keep within the basic rate earnings bracket.
There are also a number of other ways in which you could consider paying yourself, which could be more tax efficient. These could include; taking payment in stock or stock options, taking a combination of salary plus annual bonus, or creating a business agreement to defer paying yourself until the business is over the start-up phase and is more stable. There are pros and cons to each of these and we would recommend getting some professional advice to find out more.
Whatever stage you are in with your business, whether you are just starting up or are at the helm of an established business, finding the right people to help you is paramount. Here at Handpicked Accountants we aim to connect you with trusted and vetted accountants in your local area who are able to provide the specialist services that your business needs. Simply click to find an accountant today.