Most accountants will be of a mind to take dividends in place of salary because of the National insurance savings made by both the employer and employee. However, it is important to consider utilising your personal allowance and ensure you qualify for state benefits such as the basic state pension by paying sufficient salary to broach the £155 per week threshold.
Dividend income is taxed at a different rate to your salary which is subject to Income Tax. For basic rate taxpayers, tax is deemed paid by the company at 20% (assuming profits are under £300,000, rising to 21% if greater than £300,000) and will not attract a further tax charge when distributed to the recipient. For higher rate taxpayers, the additional rate of tax will be 22.5%. Dividends for higher rate taxpayers or for those with over £300,000 profit are therefore more expensive in terms of tax.
For nil rate tax payers 10% tax will be paid and therefore taking a salary subject to income tax may well be a better option for those only earning up to the £155 per week.
For basic or higher rate tax payers, National Insurance savings can be substantial. Salary demands a payment of two types of National Insurance contributions; one paid by the employer and the second by the employee. The employee rate is 12% (between £155 per week and £815 per week) and 2% thereafter. The employer’s rate is 13.8% with no upper limit. There is no extra benefit for paying more than £1 over the £155 per week.
What also may need to be considered is that, with controlling directors, lenders do not always consider the tax efficiencies of dividend payments. It is not uncommon for them to only consider a salary when calculating ‘affordability of servicing a loan‘.
Check with your lender!
Permanent health insurance may also be affected because not all plans offer inclusion of dividend income. It may be the case that you are insured for £2,000 per month but a claim may be limited to the amount of salary taken (£155×52 weeks = £8,060 per year).
Check your policy!
Pension contributions are also limited to 100% of a salary, however this limit is extended to the personal annual allowance (currently £40,000) if you can persuade yourself to pay yourself a pension rather than salary or dividend.
The tax relief, benefits and flexibility of pension contributions have ‘exploded’ in the last 12 month and will undoubtedly be covered in a later blog.
In conclusion, if you have the choice and have planned for the future you should discuss the implications of your plans with a professional financial adviser as soon as you can and more importantly well before you action any changes.