Unlike a sole trader, a director is legally separate from their limited company. Thus means you're not allowed to simply keep all the profits for yourself and instead have to decide how much to pay yourself.
As a director, the most tax-efficient way to take an income is normally a combination of a low salary through PAYE and dividend payments. Employers and employees both pay National Insurance on salary and as a director is an office holder this can be below minimum wage.
National Insurance and director's salaries
The thresholds for employer's and employee's NI differ, and if your salary is higher than the NI threshold for both employer and employee NI:
your company, as an employer, has to pay employer's NI contributions
you, as the employee, must pay NI on the salary you receive.
This means you end up paying NI twice on the same money, which isnt very tax efficient.
Using your personal allowance
Your personal allowance is the amount you are allowed to earn before you have to start paying income tax. In the current tax year, 2022/2023, the allowance is £12,570. You only pay tax on the part of your income that is above this threshold.
Qualifying for the state pension
Taking a salary which is higher than the Lower Earnings Limit (£6,396 per year in 2022/23) allows directors to build up qualifying years for their state pension. If your salary is also less than the primary threshold (£9,880) then you'll accrue the benefits of NI without actually paying it.
Tax on dividends
Whilst not subject to NI, dividends are subject to ta different tax rate than your other income. However, there is a separate dividend tax allowance that you can use alongside the personal allowance. For 2022/2023, the dividend allowance is £2,000.
Salaries as an allowable expense
A limited company pays corporation tax on the profit that it makes throughout the year. Claiming tax relief on allowable expenses reduces profit and thus the amount of corporation tax which the company pays.
Employment allowance lets small business owners reduce their National Insurance liability by up to £5,000 for the 2022/2023 tax year. It is designed to support smaller employers with their employment costs.
To be eligible, employers must have at least one employee, or 2 directors, on the payroll and have a NI liability less than £100,000 in the previous tax year.
2022/23 Director's salaries: How much should you pay yourself?
The optimum annual salary for a sole director is £9,100
The best salary if there are two or more directors is £11,908
If you're the sole director and pay yourself through your own limited company, then £758.33 a month is the most tax efficient salary yourself. This is because:
It's at the secondary threshold so your company doesn't need to pay employer's NI
Salary is lower than the primary threshold; do not need to pay employee's NI
Above the Lower Earnings Limit, so you still earn NI credits for your state pension
Less than the tax-free personal allowance threshold
If you have two or more directors, or more than one employee on company payroll, you can claim employment allowance. Over the year, you can take an annual salary up to the primary threshold without needing to pay employee's NI, and then use the £5,000 employment allowance to cover the portion of employer's NI they would otherwise incur.
Because the primary threshold increase in July 2022, you'd paying