What is the Optimum Directors Salary for 2020/21?

What is the Optimum Directors Salary for 2020/21?

The most tax efficient way for your limited company to pay you as a Director is usually through a combination of salary and dividends. We explain the best way to set up Director’s payroll to be tax efficient in 2020-21.

Why have Directors’ Salaries Changed? National Insurance Contributions (NICs) are payable by employers, as well as employees. For the past few years, the employer’s & employee’s NI thresholds have been the same.This year employees have a larger allowance than employers.

• The National Insurance (NI) Primary threshold is the point at which employees start paying NI. In 2020/21, the primary threshold is £9,500 per year.

• The National Insurance (NI) Secondary threshold is the point at which employers start paying NI. In 2020/21, the secondary threshold is £8,788 per year.

A Director is, technically, an employee of their limited company. If a Director were to take a salary of £9,600 a year from their limited company it would mean that:

• The business has to pay employer’s National Insurance Contributions, and;

• The director has to pay employee’s NI

If they’re a sole Director, they would basically be paying National Insurance twice on the same money – which isn’t very efficient.

What is the Optimum Salary for a Sole Director in 2020/21? For a sole Director on their limited company’s payroll, the optimum salary in 2020/21 is the lower threshold of £8,788 per annum. This is because a sole Director cannot claim Employment Allowance, so setting the salary at this rate means they will not incur employer’s NI.

What is the Employment Allowance? Eligible employers can use the Employment Allowance to claim up to £4,000 in order to cover the costs of employers National Insurance. Employers need to have at least 1 employee or 2 Directors on the payroll earning above the secondary threshold of £8,788 per year and the directors must not have another company that is claiming the Employment Allowance already.

What is the Optimum Salary for Two or More Directors on the Payroll, in 2020/21? If there are 2 or more Directors on the payroll, then they are entitled to claim Employment Allowance. This means they can take a salary of £9,500 each, and will not incur any National Insurance at all.

Why is it More Efficient to Pay Directors a Salary as well as Dividends? Working out the best way for company Directors to pay themselves means finding the balance between a number of factors.

Salaries are an Allowable Expense for Corporation Tax Limited companies are subject to paying Corporation Tax, but claiming allowable expenses helps companies to reduce the amount of tax that they have to pay. Salaries are classed as an allowable expense, so paying yourself a salary from the business can help lower your corporation tax bill.

Qualifying for the State Pension

By taking a salary which is higher than the Lower Earnings Limit for Class 1 National Insurance (£6,240 per year, in 2020-21) Directors are able to build up qualifying years for their State Pension. This will affect how much State Pension you are entitled to, once you pass state retirement age.

The Personal Allowance Your Personal Allowance is the amount you are allowed to earn before you have to start paying income tax. In 2020/21, the Personal Allowance is £12,500.

Clearly an annual salary of £8,788 is not high enough for most individuals to live off. The additional income is then paid to the Director as dividends. We are assuming the Director is also a shareholder.

After paying a salary of £8,788, the first £5,712 worth of dividends are tax free. (Calculation: Personal allowance of £12,500 less salary of £8,788 plus the dividend allowance of £2,000). The Director has therefore now earned £14,500 all of which is completely tax free.

The next £35,500 of dividends are taxed at 7.5%. This takes us up to the top level of basic rate, which is £50,000 for 2020/21.

Dividend tax rates for higher rate taxpayers are taxed at 32.5% and for additional rate taxpayers it is 38.1%.

DISCLAIMER – Please note that the content contained in this article is for general information only and is not a substitute for professional advice