Salaries and dividends – how to make the most out of your limited company

Working as a contractor opens up new avenues and offers you the chance to increase your skillset. By choosing to work through your own limited company you are working in the most tax efficient manner.

In this article, we discuss how contractors (working through a limited company) can earn the optimum take-home pay by using a combination of salaries and dividends.

Please note all, figures mentioned here are relevant to the 2017/18 tax year.

Money Calculation

Best way to work

In-spite of the changes that were introduced in April 2016 to how dividends are taxed, the best option for most contractors, remains, taking a small salary and the remainder in dividends. This is because dividend payments aren’t subject to National Insurance Contributions (NIC) and allows you to plan your drawings.

Contractor salaries

If you pay yourself a salary above your personal tax allowance (£11,500 for 2017/18), the portion above this allowance is subject to income tax.

It’s important to note, that not everyone has the same personal tax allowance. For the purpose of this article, we are assuming they do.

The table below explains the different portion of earnings and their corresponding income tax rates:

Band Taxable income Tax rate
Personal allowance Up to £11,500 0%
Basic rate £11,501 – £45,000 20%
Higher rate £45,001 – £150,000 40%
Additional rate Over £150,000 45%

Source: HMRC

National Insurance Contributions (NIC)

Working through a limited company means that you are both an employee and employer.  Therefore, you are required to pay NIC on employees’ gross salary that is between £155 and £866 per week at a rate of 12%. For income that is above £866 per week, this is charged at 2%.

The limited company is also liable to pay employers NIC. This is charged at 13.8% on a salary of £157 or more, per week.

Tip: By keeping your salary low you can minimise your NIC payments.

Dividends

As long as the limited company is in profit, it can issue dividend payments to its shareholders (in the vast majority of cases this will be yourself and perhaps a spouse). Dividends can be paid after Corporation Tax (charged at 19%) has been paid from the company’s profit.

How dividends are taxed

The amount of tax you pay on your dividends is linked to the income tax band you fall into.

N.B: The first £5,000 of dividends you receive in the tax year (6 April – 5 April) are tax free. This will reduce to £2,000 from 6 April 2018.

Tax band Taxable income Tax rate on dividends over £5000
Basic rate £0 – £33,500 on taxable income over personal allowance 7.5%
Higher rate £33,501 – £150,000 on taxable income over personal allowance 32.5%
Additional rate Over £150,000 of taxable income 38.2%

Source: HMRC

How this combination works:

  1. Take a salary of £8,164 (£680.33 per month)
  2. Use remainder £3,336 of personal allowance to take dividends
  3. Use dividend tax allowance (£5,000) to take further dividends
  4. This will give you a tax-free earning of £16,500.

Closing thoughts

Contractors using a combination of salary and dividends pay less tax and have a greater take-home pay, then a contractor just paying themselves a salary. This is because NIC payments are minimised.

Before, you decide on the level salary and dividend you will take, please consultant with an experienced contractor accountant. Our team has helped thousands of contractors over the last 20 years. Give us a call on 01962 867550 or submit your enquiry and we’ll call you back.