Understanding the Tax Benefits of Dividends for UK Ltd Directors: Why Some Opt for Taking £12,570 in Wages and the Remainder in Dividends
In the realm of UK business ownership, particularly for directors of limited companies, tax efficiency remains a fundamental consideration. Among strategies employed to optimize personal income and minimize tax liabilities, many directors choose to take a modest salary—often around £12,570—and supplement their earnings with dividends drawn from company profits. This approach has garnered attention and questions from entrepreneurs and advisors alike, prompting an exploration into its rationale.
The Common Practice: Low Salaries and Dividends
The practice of drawing approximately £12,570 as a salary aligns with the current Personal Allowance threshold, beyond which income tax becomes payable. By setting the salary at this level, company directors ensure compliance with National Insurance contributions (NIC) requirements while avoiding unnecessary tax on earnings. The remainder of income—often substantial—is then taken as dividends, which are taxed differently from earned income.
The Tax Landscape
Understanding the tax implications involves considering several key rates and thresholds:
- Income Tax Personal Allowance: Up to £12,570, tax-free.
- Basic Rate Income Tax: £12,571 to £50,270, taxed at 20%.
- Corporation Tax: Currently 19%, applicable to company profits.
- Dividends Tax Rates: After the introduction of the dividend allowance, dividends are taxed at 8.75% within the basic rate band.
Why Not Just Increase the Salary to the Basic Rate Threshold?
Some might question whether it is more straightforward to increase the salary to the full basic rate threshold (£50,270), paying income tax at 20%, and then distribute remaining profits as dividends. This approach simplifies tax planning and ensures personal earnings are within the lower tax bracket.
However, there are nuanced reasons why many choose to keep their salary below this level:
-
National Insurance Contributions (NIC):
Salaries above the NIC threshold incur both employee and employer NIC contributions. By maintaining a salary at or just above the NIC threshold (~£12,570), directors avoid significant NIC liabilities, whereas higher salaries attract additional costs. -
Tax-Efficient Dividends:
Dividends are taxed at lower rates (8.75% within the basic band), which can result in overall tax savings. Distributing profits as dividends after a modest salary allows business owners to benefit
