When you’re the boss, paying yourself may seem confusing and surreal. Here’s everything you should consider before giving yourself your first payslip.
You put a lot of effort into starting your business and making it grow. Now the time has come to take money out for yourself. But how much should you take?
Working out how much to pay yourself can be confusing for a new business owner. But it doesn’t need to be a complicated decision.
What you pay yourself is a reflection of the hard work it took you to bring your business to life. And when you get to enjoy that moment, it’s a fantastic experience. In this guide, we’ll show you exactly how to pay yourself, and what factors and tax implications you need to consider before withdrawing any cash from your business.
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UK Business Structures
Sole traders pay income tax on profits over the personal allowance of £12,570. How much you pay will depend on how much you earn:
- 20% for income between £12,571–£50,270
- 40% for income between £50,271–£150,000
- 45% for income over £150,000
There are different income tax rates in Scotland.
Sole traders also pay Class 2 and Class 4 National Insurance contributions at varying rates, depending on their earnings:
- Nothing for profits under £6,515
- £3.05 per week for profits between £6,515–£9,568 (Class 2)
- 9% for profits between £9,569–£50,270 (Class 4)
- 2% for profits of £50,270 and above (Class 4)
And if you earn more than £85,000, you’ll need to register for value added tax (VAT).
Each individual in a partnership registers as a sole trader and pays the same rates of income tax and National Insurance contributions above on their share of the profits. The partners also pay VAT if they earn more than £85,000.
Limited Liability Partnership (LLP)
As with sole traders and partnerships, each member of an LLP must register as self-employed, complete a self-assessment tax return, and pay income tax, National Insurance contributions, and VAT (if they earn over the threshold).
Limited companies need to pay corporation tax on their company profits. The flat rate for corporation tax is currently 19% and is payable 9 months and 1 day after the end of your accounting year.
You can also pay yourself in dividends. These are tax-free for the first £2,000 and subject to lower tax rates of:
- 7.5% for the basic rate
- 32.5% for the higher rate
- 38.1% for the additional rate
If you pay yourself a salary from a limited company, you’ll need to deduct Class 1 National Insurance employee contributions from this and pay these to HMRC. Your company will also have to pay Class 1 employer National Insurance contributions at 13.8% unless this is covered by the employment allowance.
The rates for Class 1 employee National Insurance contributions are:
- 12% for pay between £717–£4,189 per month
- 2% for any pay over £4,189 per month
And lastly, you’ll need to pay VAT on any profits over £85,000.
Business Running Costs
As well as paying income tax and National Insurance Contributions (or corporation tax and dividends taxes if you’re the owner of a limited company), you need to think about your business expenses. You’ll need enough money in your business bank account each month to cover the costs of these.
Your business running costs might include:
- Professional indemnity insurance: Usually paid in monthly instalments, it can help you out in the event of facing problems with a client
- Accountancy fees: While there’s no legal requirement to work with an accountant, their knowledge of the UK tax system can help you make significant tax savings
- Stationery and office equipment: Think about your computer and any other items you need to be able to do your job
- Accounting or bookkeeping software: You can create quotes and invoices yourself, but using software may help you appear a little more professional
- Marketing costs: Think about your website, email marketing campaigns, and any events you register to appear at
- Salaries and pension contributions: If you employ staff, remember you need to pay them and contribute to their pensions if their earnings fall within the threshold
Paying Yourself as a Sole Trader, Partnership, or LLP
Sole traders, and individuals in a partnership or LLP, don’t receive a traditional salary. They pay themselves by taking money directly out of the business. These are known as drawings. For this reason, it helps to have a separate business bank account for your self-employed income, and take money out of this at the times and amounts that suit you.
These personal drawings are counted as profits and are taxable at the end of the tax year. So remember to keep some money aside each year that you can use for paying tax.
Paying Yourself as a Limited Company
If you run a limited company, consider paying yourself a modest salary as part of your overall earnings. £12,570 will put you in an income tax-free bracket.
Salaries are also a deductible business expense, so withdrawing something will help you to lower the cost of your corporation tax bill too.
You can top up your modest salary with dividend payments. These are tax-free for the first £2,000 you withdraw during the tax year, and dividend tax rates are lower than income tax rates.
The dividend rates are:
- 7.5% for the basic rate (up to £50,270)
- 32.5% for the higher rate (between £50,271–£150,00)
- 38.1% for the additional rate (above £150,000)
Limited company owners can also make pension contributions for their employees or directors. The contributions you make can be deducted from your corporation tax bill. And assuming this falls within the recipient’s pension allowance, the amount won’t be taxed until the recipient withdraws it from their pension pot.
In most cases, individuals can withdraw 25% of their pension fund tax-free. And pension allowances are usually £40,000 per year. You can also use unused allowances from the previous 3 years, making pensions a tax-efficient way of taking money out of your limited company.
Are You Prepared to Pay Yourself?
As a business owner, paying yourself isn’t just about earning money. It’s about earning money from the ideas you believe in. And when that day finally comes, you can sit back and relax as your hard work pays off.
There’s a lot you need to consider, from tax efficiency and expenses to pension contributions. So give yourself some credit for tackling these subjects head-on (or working with an accountant to help you navigate the UK tax system).
From making a business plan and seeing it through to growing your business revenue, many business owners don’t make it this far. So another congratulations is in order for getting to where you are today.