Salaries vs Dividends: Which is Most Appealing?

Whether you realise it or not, your income will play a big part in your life. This is why individuals tend to look for ways to create several profits or even have the option to select between the kind of monetary benefits they receive. Both salary and dividends are technically incomes, the main difference is, one you buy beforehand and earn a profit on, and the other is paid to you for your services to a company. You may find yourself asking, which is the better option for me, a salary or dividends?

With this in mind, in this blog we are going to look at the various ways you may wish to extract profit as an employer, the two main options being that of salaries or dividends.

Let's explore both of these in detail and help you answer the question; salaries vs dividends, which is most appealing?

Taking a salary

Salary can simply be paid to you. If you have an employment contract you will be required to comply with National Minimum Wage demands. This means most directors or shareholders do not possess one. This also has implications in the scenario of redundancy. There is a salary at which the director pays 0% national insurance, but will still be able to qualify for pension, sickness and other benefits. This is £8,788 per annum 2020-21.

If the company has unused Employers Allowance because of additional employees, it may be more beneficial to pay a salary to the director of the annual personal allowance of £12,500 per annum 2020-21.

As a company director, it's a good decision to take at the very least a small salary. This indicates that you are putting yourself on your company's payroll. There are a couple of benefits of taking part of your income as a salary to be considered.

The pros of taking a salary vs dividend

You can build up qualifying years towards your state pension
You will be able to make higher personal pension contributions
You can retain maternity perks
It can be simpler to apply for mortgages and insurance policies such as critical illness cover
You lower the amount of corporation tax that your company pays (such as salary is an allowable business expense)
You can take a salary even if your business makes zero profit

The cons of taking a salary vs dividend

Taking a salary means that you and the company have to pay National Insurance contributions (NICs)
A salary also draws higher rates of income tax than a dividend will do

What are dividends?

A dividend is a share of the company's profits. Profit is what is left over after a company has settled all its liabilities, this includes taxes. If there is no profit, then no dividends can be given. Dividends can be paid to a director or other shareholders, this will be in keeping with the proportion of shares that they hold. There is no specific requirement to pay the profits as dividends or even just some of them. A company can keep profits over a number of years and distribute them as the board chooses.

Dividends are a share of the profits which can be paid to business shareholders as a return on their investment. Unlike paying salaries the business must be making a profit (after tax) in order to qualify for dividends. Due to there being no national insurance on investment income it is frequently seen as a more tax-efficient way to extract money from your business, rather than opting for a salary.

There is a tax-free dividend allowance in place for the first £2,000 per annum, after which the tax rate on company dividends then comes in at 7.5% or 32.5% (2020-21) varying on your other income. Only shareholders can gain dividends as a reward for their investment. It is also worth noting that directors who are not shareholders will not receive dividends.

The pros of taking dividends vs salaries

Dividends draw in lower rates of income tax than a standard salary
No NICs are payable on dividends (neither employers nor employees)
By taking most of your income in the form of dividends, you can lower your income tax
Generating passive income as stable dividends are one of the most important factors in a company's capability to keep its stock price strong
They allow you to invest once and profit twice - When you invest in dividend stocks, you could profit in more ways than one

The cons of taking dividends vs salaries

Dividends can only be paid out of profits
Depending too much on dividends can mean that your income is unpredictable
Dividends are paid in after corporation tax has been deducted (this varies from a salary, which is a tax-deductible expense)
If you accidentally claim a dividend that is not covered by profits, you will have taken out a director's loan which needs to be repaid
Dividends don't class as 'relevant UK earnings' for the purposes of tax relief on pension contributions that need to be made yourself

So, which is best? Salaries or dividends?

We hope this overview of salaries vs dividends has been helpful. The bottom line when deciding which is most appealing, is that it all comes down to a business owner's situation. Salary and dividend options both have their pros and cons, and a good decision can only be made after much consideration and an economic reflection made of one's business in the long run.

Keith Graham's Payroll Services

Here at Keith Graham, we can help to relieve the burden of administering your payroll

with our comprehensive payroll service. This includes customised payslips, administration of PAYE, CIS returns, summaries and analyses of staff costs and plenty more. For professional payments every time - Contact us on 01252 312561 or you can email us at info@keith-graham.co.uk. You can also fill out our quick and easy online form.