Finding The Balance - The Optimal Salary for Directors in 2021/22

Each tax year, directors need to make decisions about how to structure their remuneration. Typically, that includes a basic salary and dividends.

The optimal salary depends on several factors:

  • Whether they have additional income or employment.
  • Their income tax bracket and applicable income tax rates.
  • Whether they have passed retirement age.
  • Dividend income tax rates.
  • National Insurance rates for the tax year in question.

In this article, the SAS team summarises the ideal salary for directors, per the 2021/22 National Insurance rates, and how this is calculated.

For more information about structuring salaries and dividend income for directorships, please get in touch.

What is the Ideal Director's Salary?

For 2021/22, the balance is met with a salary of £8,840 a year. That works out as:

  • £736 basic wage per month.
  • £170 in salary payments a week.

Directors who own their businesses can usually decide on their pay, and so by using the optimal salary, they can balance out their income and avoid paying unnecessarily high taxes.

The difference between their agreed annual remuneration and the £8,840 salary should be paid as dividends.

In this tax year, the lower earnings limit for National Insurance is £6,240 a year. Therefore, if you earn above this value, you make sufficient contributions towards your State Pension benefits.

Above that, the secondary earnings threshold is £8,840. If you earn above that amount in salary payments, the business will become liable for employer's National Insurance contributions.

Therefore, it makes sense to fix your salary at the secondary earnings limit to ensure you continue to qualify for a future State Pension but are not liable for business NI payments.

Can Directors Be Paid Solely Through Dividends?

Given the complications of needing to file tax returns and adjust their annual salary, it might appear that forgoing a salary altogether and being paid 100% through dividends would be a more straightforward solution.

There are several reasons why that isn't an optimal strategy:

  • Salaries are tax-deductible, whereas dividends are not. Having this proportion of remuneration paid as a wage means the business benefits from reducing their 19% corporation tax exposure.
  • Paying a salary of £8,840, rather than as a dividend, saves the business £1,679 in corporation tax for the year.
  • If you do not pay yourself any salary, you are not making contributions towards your eligibility for the State Pension.

However, there are some circumstances where a different approach is advisable, for example, if the director is eligible for tax allowances.

If you have another income source, it might be better to pay all remunerations through dividends. Likewise, a director past retirement age won't need to continue making NI contributions to be eligible for the State Pension.

Is It Worth Splitting Directors Pay Between a Salary and Dividends?

In most cases, yes, the benefits outweigh the administrative work involved in running a payroll entry for the director and producing dividend vouchers.

Every individual has a tax allowance, currently £12,570 below which they won't need to pay income tax - so paying £8,840 as a salary will not attract any income tax.

National Insurance employer's contributions apply to income over £8,840, so keeping the salary capped at this level ensures no business obligations arise. Combined National Insurance and income tax contributions deducted from PAYE salaries are much higher than the tax payable on dividends, so this strategy reflects a cost-saving method.

After receiving a salary of £8,840, the remaining personal allowance means that £3,730 of dividends are tax-free, plus the £2,000 tax allowance on dividends - the director, therefore, receives £14,570 of tax-free income.

Dividends are then taxed at 7.5% up to £37,700. That tax rate increases to 32.5% for income between £37,701 and £150,000, and 38.1% for dividends over £150,000.

There may be some cases where it is, however, better to pay a higher salary. Those include:

  • When the director cannot be paid in dividends because the company has made losses.
  • Where dividends available are lower than the required remuneration.

Note that the optimal salary for directors can change yearly, depending on the thresholds and tax allowances available. In 2019/20, it was £8,632, and in 2018/19, £8,424.

If you'd like to verify whether this optimal strategy presents a tax saving for your and your business or to run through your current tax liabilities compared to those available, please contact the SAS Accounting team!


This product has been added to your cart