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 2020/21 you will need to have at least £6,240 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 £6,240, right? Wrong.
Now let us think about the second point.
If you paid yourself £6,240, you save yourself and your company on paying income tax and national insurance, but you’re wasting £6,240 of your personal allowance.
With the introduction of the Employment Allowance, in 2014/15, means that the first £4,000 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 £12,500 per year (£1,042 per month), this will cost you just over £445 in personal national insurance and just over £512 in employers national insurance, but the employers national insurance will be reimbursed under the Employment Allowance scheme, so you will save over £262 in corporation tax. If you are not a qualifying employer the optimum salary is £8,788 per year (£732.33 per month).
The PAYE thresholds, rates and allowances (used in our calculations):
- Annual personal allowance is £12,500 per annum (£240 per week or £1,042 per month);
- Lower earnings Limits is £6,240 per annum (£120 per week or £512 per month);
- Primary and secondary threshold is £8,632 per annum (£166 per week or £732.33 per month);
- Employees’ class 1 rate 12% (Between the primary and upper earnings limits);
- Employers’ class 1A rate 13.8% (first £4,000 is reimbursed, if employer qualifies);
- If you wanted to avoid national insurance on your salary altogether you would have to pay yourself less than £8,788 and you would also waste £3,712 of your personal allowance, which your company would have to pay £705.28 in corporation tax.
- Personal National Insurance (£12,500 – £8,788 x 12% = £445.44);
- Employers National Insurance (£12,500 – £8,788 x 13.8% = £512.26);
- Corporation Tax Saving (Corporation Tax due on difference between personal allowance and secondary threshold less personal National insurance (£707.58-£445.44 = £262.14));
- If you do not qualify for employers allowance, it may not be beneficial to you to pay yourself £12,500, and the optimum salary would be £8,788
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
More information about National Insurance, Income Tax rates and allowance or Employment Allowance can be found on HMRC’s website
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.