Do I need a remuneration strategy?
As an owner-manager, your chief concern will be making your business profitable and building up cash reserves in the company. But you’ll also want to be able to extract funds from the business too – whether this is via a regular monthly salary or ad-hoc dividend payments.
Salary vs dividends is the most common split. Still, there are several different ways of extracting funds from your business, all of which can have other tax and capital impacts – both for you personally and the company as a whole.
Because of this, it’s essential to have a clear and workable remuneration strategy – which sets out how and when you will be able to take funds out of the company.
Building a tax-efficient remuneration strategy
Once your business is financially stable, you’ll undoubtedly have thought about taking income from the company, mainly how to split income between salary and dividends.
So, what are the primary considerations when creating a remuneration strategy?:
Your first choice is generally to ask ‘How much should I take as a salary?’. Presuming that you don’t have a contract of employment with your company (most owner-managers don’t), then the National Minimum Wage legislation doesn’t apply.
To build up credits (contribution years) for the state pension, your salary has to be paid at a rate that’s equivalent to at least the Lower Earnings Limit (LEL) of £520/month. Generally, therefore, a salary of at least that amount should be taken.
Individuals currently pay National Insurance (NI) contributions at 12% on salary between £797 and £4,189, and at 2% on salary over that level. However, it’s recently been announced that the NI rates will be rising from April 2022 to provide funding for the Government’s new Health & Social Care Levy.
From April 2022, NI rates will increase as follows: for employees with annual earnings between £9,568 and £50,270, the National Insurance rate increases from 12% to 13.25%, an increase of 10.4% above current levels. On earnings over £50,270, the rate is over half as much again, changing from 2% to 3.25%. These increased NI deductions will need to be factored into your strategy.
The company will have to pay Class 1a and 1b employer NI contributions at a rate of 13.8% for all salaries above £737 per month. But these contributions may be partly or wholly covered in some circumstances by the NI employment allowance.
There’s a ‘sweet spot’ between £520 and £737/£797 where no NI is payable by either party, which can be a significant factor in the amount of salary you payout. This sweet spot is also below your income tax threshold as an individual – you’re considered a contributor to earn state pension benefits, and the salary is deductible against the company’s profits for corporation tax purposes.
Above this sweet-spot level, it’s sensible to consider whether or not to take dividends. Bear in mind that dividends can only be paid out of after-tax company profit, so your business does need to have delivered this profit before you can extract any cash as a dividend payment.
The first £2,000 of dividends are tax-free for the recipient, but above that, the rate depends on which tax band the dividends fall into. If you have any unused personal allowances, then dividends that fill that gap are tax-free.
These rates will increase by 1.25 percentage points from April 2022. Dividends in the basic-rate band (generally total income between £12,570 and £37,700) are taxed at 7.5%. Dividends in the higher-rate band are taxed at 32.5%, and anything above that is taxed at 38.1%.
Other ways in which funds can be extracted from the company include paying off amounts due on any director’s loan account, making a loan to you as a director (which can have other consequences), making contributions to your director’s pension fund and providing benefits in kind.
As with all of these things, the driver behind your remuneration strategy needs to be the needs of the business, not the short-term, positive tax implications for you personally. But, of course, there will always be specific considerations to factor in for each scenario and each individual. So it’s good practice to talk to your accountant in advance of extracting any funds from the business.
Talk to us about your remuneration strategy.
In most cases, there’s no shortcut to crunching the numbers when it comes to creating a robust remuneration strategy. It requires an excellent understanding of both company and personal tax and a good knowledge of the complex (and sometimes opposing) effects of company and personal taxes on each other.
We’ll help you to review your business and personal wealth situations and generate a remuneration strategy that’s tax-efficient, straightforward and well-suited to your cash needs.
Get in touch to talk through your remuneration plans.