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 2021/22 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 £6,330 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 £12,570 per year (£1,047.50 per month), this will cost you just over £468 in personal national insurance and just over £505 in employers national insurance, but the employers national insurance will be reimbursed under the Employment Allowance scheme, so you will save over £240 in corporation tax.
In the example we are assuming you do not qualify for the Employment Allowance and want to pay £o in National Insurance
If you are a qualifying employer (for the Employment Allowance), the optimum salary is £8,788 per year (£732.33 per month), this will cost you £0 in personal national insurance and £0 in employers national insurance.
If you were to pay yourself the personal allowance of £12,570 per year, this this will cost you just over £468 in personal national insurance and just over £505 in employers national insurance, so a total of over £973. Corporation Tax due on the difference between your personal allowance and the secondary threshold would be just under £709, so you would save £264 in tax.
In the example we are assuming you do not qualify for the Employment Allowance
If you are a qualifying employer (for the Employment Allowance), the optimum salary is £9,568 per year (£797 per month), this will cost you £0 in personal national insurance and just over £100 in employers national insurance.
Corporation Tax due on the difference between your personal allowance and the primary threshold would be just over £570, so you would save just over £303 in tax.
So overall, if you qualify for employment allowance the optimum salary is £12,570 per year, if you do not qualify then it is £9,568.
Notes:
The PAYE thresholds, rates and allowances (used in our calculations):
- Annual personal allowance is £12,570 per annum (£241.73 per week or £1,047.50 per month);
- Lower earnings Limits is £6,240 per annum (£120 per week or £520 per month);
- Secondary threshold is £8,840 per annum (£170 per week or £737 per month);
- Primary threshold is £9,568 per annum (£184 per week or £797 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 £8,840 and you would also waste £3,730 of your personal allowance, which your company would have to pay £708.70 in corporation tax.
- Personal National Insurance (£12,570 – £8,840 x 12% = £468.48);
- Employers National Insurance (£12,570 – £8,840 x 13.8% = £505.08);
- Corporation Tax Saving in the first example (Corporation Tax due on difference between personal allowance and secondary threshold less personal National insurance (£708.70-£468.48 = £240.22));
- Corporation Tax Saving in the second example (Corporation Tax due on difference between personal allowance and secondary threshold less personal National insurance (£973.56- £708.70 = £264.86));
- Corporation Tax Saving in the third example (Corporation Tax due on difference between personal allowance and secondary threshold less personal National insurance (£973.56- £570.38-£100= £303.18).
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
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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.