Navigating Your Personal Allowance: Salary vs. Dividends for Maximum Tax Efficiency
Wondering whether you’ve exhausted your personal allowance for the year or not can seem perplexing as you venture into new employment arrangements. Here’s the situation: You’re preparing to leave your current full-time job in August, during which you’ll have received a gross salary of approximately £25,000 since the start of the tax year.
With your limited company set up, your plan is to draw a salary of £12,500 and supplement the rest with dividends—a common approach for many entrepreneurs. This brings forth your primary question: Have you already utilized your personal allowance for the current year? Should you focus solely on dividends, taking advantage of the 8.75% dividend tax rate, until the new tax year begins?
This may initially feel like an unnecessary concern, but opting for dividends could simplify administrative processes. It would mean deferring payroll until 2025, using tools like FreeAgent or Mettle to handle dividends payments seamlessly.
Receiving insights or advice from a tax professional or someone familiar with your unique financial situation could be significantly beneficial. If anyone has experience in this area, I’m eager to hear your thoughts and guidance. Thank you!
1 Comment
bdadmin
First off, rest assured that your question is anything but stupid—navigating tax issues can be complex, and it’s important to have a clear understanding to make informed decisions about your financial situation. Let’s break down your situation and consider the most pragmatic approach moving forward.
Understanding Your Personal Allowance
The personal allowance for the 2023/2024 tax year is £12,570, meaning you won’t pay any income tax on earnings up to this amount. Since you’ve earned around £25k from your full-time employment, you have indeed surpassed the annual personal allowance. Thus, any additional salary or dividends will not benefit from the tax-free personal allowance.
Consideration for Taking Salary vs. Dividends
With your current earnings, any salary taken from your limited company will be subjected to income tax and possibly National Insurance Contributions (NICs), based on the total income exceeding your personal allowance. Since your new company will grant you a salary of £12.5k, already close to the personal allowance limit, the balance will be taxed at the basic rate of 20% (plus employee NICs over certain thresholds).
On the other hand, dividends have multiple tiers of taxation, with the first £1,000 tax-free (under the dividend allowance), then taxed at 8.75% for basic-rate taxpayers. This makes dividends a tax-efficient method of withdrawing money from your company after surpassing the personal allowance through other income.
Practicalities and Strategy
Given your scenario, relying more on dividends might be prudent. Not only are they taxed at a lower rate compared to salary after crossing the basic allowance, but they also avoid NICs. Here’s a step-by-step strategy you could consider:
Pause Salary Withdrawals: As you’ve reached the total income that exhausts the personal allowance, you might want to focus on dividends to maximize your tax benefits. Holding off on salary payouts minimizes higher taxation and administrative workload temporarily.
Dividends Payment: Utilize your dividend allowance. Keep in mind that drawing dividends requires company profits, meaning they can only be paid if the company shows a profit after corporation tax. Ensure accurate and compliant documentation, including issuing dividend vouchers and holding board meetings to record dividend decisions.
Plan for the Upcoming Tax Year: Consider timings when approaching the end of the tax year. Proper timing of dividend payments can assist you in strategizing tax liability between two tax years.
Consult a Tax Advisor: Individual circumstances can