As a contractor working through your own limited company, you will have the option to decide when and how to extract funds from this company.

There are a few different options available to you, two of which are to pay yourself a salary, take money in the form of dividends or a mixture of the two. Since these levels will depend upon your income and your circumstances, the best way will be unique to you and your company.

To help you decide the most tax efficient structure for you and your company, we’ve put together some advice.

What are dividends?

Dividends are an alternative way of paying yourself using the profits from your company. Limited companies can issue dividends at the end of the financial year, and at points throughout the year, which is common when the directors or shareholders rely on this for income. As long as your company is turning a profit, you should be able to draw dividends.

You can find more information in our comprehensive guide.

How are salary and dividends taxed?

Dividends work differently than a PAYE salary because they are not liable for any National Insurance and less Income Tax than a salary. This makes them an attractive option for directors. 

What is the tax allowance for dividends?

Taxable Income

Tax Band

Tax Rate

£0 – £33,500

Basic Rate

7.5%

£33,501 – £150,000

Higher Rate

32.5%

£150,000 +

Additional Rate

38.1%

(correct as of 2018/19)

Salary, on the other hand, is liable for tax and National Insurance contributions, which will be taken as a proportion of your earnings. 

What is the tax allowance for salary?

The tax thresholds are currently as follows:

Taxable Income

Tax Band

Tax Rate

Up to £11,850

Personal Allowance

0%

£11,851 to £46,350

Basic Rate

20% of income

£46,351 to £150,000

Higher Rate

40% of income

Over £150,000

Additional Rate

45% of income

Should I pay myself a salary or dividends?

Paying yourself via a salary can be a cost effective way of drawing money out of your company, but as you pass the National Insurance threshold, your tax efficiencies may begin to decrease. 

The personal allowance rate rose from £11,500 to £11,850 in 2018. Similarly, the dividend allowance dropped from £5,000 to £2,000. The changes in allowance means that it could actually be more tax efficient to pay yourself a larger salary and reduce your level of dividends for the financial year. However, despite these tax hikes, there is flexibility over the time in which you need to declare dividend payments, which make them an attractive prospect for many.

Ultimately, deciding whether to pay yourself salary or dividends will depend on your circumstances, your level of income and the tax bracket you fall into.

Utilising a tax efficiency structure

Though personal circumstances are different for each contractor, most find that paying themselves a combination of dividends and salary is the most tax efficient way of working. This involves the contractor paying themselves a salary up to the tax free allowance and subsidising the rest of their profit via dividends and is a popular method of working.

Find out more

When it comes to getting paid, it’s not always simple to decide  which route is best for you. Luckily, we’re here to make the process easy. 

For more information about salary, dividends and making the most of your limited company funds, our guide is here to help.