Such a simply question, you would think, however it produces a complicated answer. For this calculation, we have assumed the following:
- The director wants to preserves their entitlement to state benefits, and
- The director wants a salary which saves the most tax and national insurance.
First of all let us look at preserving your entitlement to state benefits. To preserve your entitlement to a full state pension you currently need 30 qualifying years. In 2017/18 you will need to have at least £5,876 of earnings (going through a PAYE scheme, from one employer) for it to be a qualifying year. Paying yourself this amount also means neither you nor your company, would have any income tax or national insurance to pay.
So you’re now thinking I will just pay myself £5,876, right? Wrong.
Now let us think about the second point.
If you paid yourself £5,876, you save yourself and your company on paying income tax and national insurance, but you’re wasting £5,624 of your personal allowance.
With the introduction of the Employment Allowance, in 2014/15, means that the first £3,000 of your national insurance (Class 1) bill is reimbursed to you (Sole directors/employee do not qualify for this allowance from 2016/17).
In the example we are assuming you qualify for the Employment Allowance
If you are a qualifying employer (for the Employment Allowance), the optimum salary is £11,500 per year (£958.33 per month), this will cost you just over £400 in personal national insurance and just over £450 in employers national insurance, but the employers national insurance will be reimbursed under the Employment Allowance scheme, so you will save over £1,124 in corporation tax. If you are not a qualifying employer the optimum salary is £8,164 per year (£680.33 per month).
The PAYE thresholds, rates and allowances (used in our calculations):
- Annual personal allowance is £11,500 per annum;
- Lower earnings Limits is £5,876 per annum (£113 per week or £489.66 per month);
- Primary and secondary threshold is £8,164 per annum (£157 per week or £680.33 per month);
- Employees’ class 1 rate 12% (Between the primary and upper earnings limits);
- Employers’ class 1A rate 13.8% (first £3,000 is reimbursed, if employer qualifies);
- Corporation tax saving (£11,500-£5,876 = £5,624 x 20% = £1,124.80);
- Personal National Insurance (£11,500 - £8,164 x 12% = £400.32);
- Employers National Insurance (£11,500 - £8,164 x 13.8% = £450.36);
- If you wanted to avoid national insurance on your salary altogether you would have to pay yourself less than £8,164 and you would also waste £3,336 of your personal allowance, which your company would have to pay £667.20 in corporation tax.
- If you do not qualify for employers allowance, it may not be beneficial to you to pay yourself £11,500.
Get a State Pension Statement to find out how many qualifying years you already have.
More about the basic state pension can be found here: https://www.gov.uk/state-pension/eligibility
The information provided in this blog and all our blogs is of a general nature. It is not a substitute for specific advice in your own circumstances. This information can only provide an overview of the regulations in force at the date of publication, and no action should be taken without consulting detailed legislation or seeking professional advice.