EP-1 : How to Pay Yourself as a Business Owner: Salary, Dividends & Tax Efficiency

Episode Summary:

In this episode of Money, Machines & Margins, we break down the best ways for business owners to pay themselves while minimizing taxes. Learn about the PAYE salary vs. dividends strategy, how to structure your earnings for maximum efficiency, and common mistakes to avoid.

What You'll Learn:

✅ How much salary to take as a business owner in 2024/25.
✅ The best way to mix salary and dividends for tax efficiency.
✅ Why leaving all profits in the business isn’t always smart.
✅ When to switch from sole trader to limited company.

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Transcript

Speaker 1: 0:00

Welcome to Money Machines and Margins, the podcast for SME owners in British manufacturing and industrial space who want to build profitable businesses and secure their financial future. I'm Heather, your host, a chartered accountant and a financial strategist for manufacturing SMEs. Running a business is tough, but managing your personal finances as a business owner, that's a whole different challenge. Today we are diving into a crucial topic how should you pay for yourself as a business owner? Should you take a salary, take dividends or perhaps a mix of both? And, most importantly, how can you do it in the most tax efficient way possible? This episode is packed with practical advice to help you get the most out of your hard earned money. Let's get into it. Firstly, paying yourself properly matters. Now. Most business owners either overpay themselves, thereby harming the business cash flow, or underpay themselves, thereby hurting their personal finances. The goal here is to maximise your take home pay while minimising the tax and keeping cash flow in the business strong. Common mistakes that business owners make here are taking an irregular income, thereby making the personal budgeting impossible. Secondly, paying yourself only through dividends Now, this is not always tax efficient. And thirdly, forgetting about pension contributions and long-term financial security long-term financial security for themselves and their loved ones. The takeaway here is you need to pay yourself the right way, and paying yourself the right way isn't just about tax. It's about sustainability and financial planning, not just for your business, but for yourself. Next, we look at the main ways to pay yourself. Now there are two main ways in which you, as the business owner, can pay yourself. Option one is a PAYE or pay as you earn salary. If you're a director of a limited company, you can pay yourself a salary. The pros of this approach are it helps you build pension contributions and state benefits. It gives you a fixed income to make your personal budgeting a bit easier, and it can be deducted as a business expense, thereby lowering your company's corporation tax. The cons here are, firstly, that salary is subject to income tax and national insurance, and it's not as efficient as dividends. The sweet spot here is pay yourself the optimal salary amount, and what I mean by this is the salary amount that's under the personal allowance threshold. In the uk for the 2024 and 2025 tax year, the optimal salary is £12,570 per year. Paying yourself. This would keep you under the personal allowance threshold, thereby avoiding not just tax but NI contributions as well, if structured correctly. The second option you have here is paying yourself dividends. These are amounts that business owners can pay themselves from company profits. The pros of paying yourself dividends are that dividends have a lower tax rate than salaries and there are no national insurance contributions. The cons here are you must pay corporation tax first. So what does this mean? Any profits that you have, you deduct the corporation tax first and then from the remaining amounts you can pay yourself dividends. Guaranteed your business actually needs to make a profit before you can pay yourself dividends. So what's the sweet spot here? The sweet spot here is, after taking a salary of twelve thousand five hundred and seventy for every director, you take dividends up to the basic rate tax band, which means you have total earnings of 50 270 and this would allow you to stay in the 8.75 percent tax bracket.

Speaker 1: 4:37

Next we look at how to mix salary and dividends for maximum tax efficiency. Now. In the previous two segments we looked at Now in the previous two segments we looked at how to pay yourself through a salary and tax dividend. There is an optimal mix for both these. The way you structure that is, you pay yourself a salary of £12,570 per annum, tax-free, and then you stack dividends of £37,700 on top of that. That way, you stay within the lower tax band of 8.75% for your dividends. Anything above this means you get hit with a higher tax rate of 33.75%. So be strategic of 33.75%. So be strategic also pro tip here. If you do not need that money personally, leave the profits in the business to either reinvest in the business and give yourself better revenues, better returns in the future, and save on taxes now.

Speaker 1: 5:49

In the previous three segments we worked on the base assumption that the business is structured as a limited company. What about sole traders and partnerships? In these business structures, a sole trader and a partner does not take a salary or dividends. They take drawings from business profits. Also, sole traders are taxed on total profits, so planning expenses is crucial, which is why, if your profits reach around the 50 to 60K mark, it's generally considered more tax efficient to set up as a limited company. So the main takeaway here is the right structure for you and your business is one that allows you to create the maximum earnings for yourself and your family while keeping the business sustainable, because that's why you set up a business. So we looked at all the various ways in which you could pay yourself as a business owner and how and the best ways to structure it, given different legal structures.

Speaker 1: 6:59

What are the mistakes you need to avoid? The three most common mistakes you need to avoid are firstly, taking too much in dividends and forgetting about pension planning. Number two, leaving all profits in the business without a withdrawal plan. And number three, not planning for tax bills. Here, what you need to keep in mind is ideally set aside at least 30% of your profits for taxes.

Speaker 1: 7:30

And the final tip on this work with an accountant like me to optimize your salaries and dividends mix each year, because each year your circumstances will change. The business's circumstances will change, the laws will change, the personal allowance limits will change. The laws will change, the personal allowance limits will change. So every year, you need to sit down with your accountant to have a look at this with a fresh pair of eyes. That's it for today's episode. Hopefully, you now have a solid understanding of how to pay yourself as a business owner while keeping your tax bill low. How to pay yourself as a business owner while keeping your tax bill low. If you found this helpful, do me a favor and subscribe to Money Machines and Margins so you never miss an episode, and if you've got any questions about managing your money as a business owner, send them in. I might cover them in a future episode. Thank you for tuning in. See you next week.