Salary, dividend or pension contribution?

Newsletter issue - March 2015.

When you work for your own company you can decide how much salary to pay yourself, how much to pay into your pension fund, and what proportion of the remaining profits to take as a dividend. The split is important as it will affect the tax and national insurance payable by you and your company.

A salary just sufficient to be covered by your personal allowance (Â£10,600 for 2015/16), will be tax free, assuming you have no other income. However, if your company has more than one employee (including directors), a salary of over Â£10,000 (for 2015/16) will mean the recipient has to be automatically enrolled in the company's pension scheme, under the auto-enrolment rules.

You must pay national insurance contributions (NIC) at 12% on your salary above Â£8,060. So if the company pays you Â£10,600, you take home Â£10,295 after NIC deductions. The company will also pay employer's NIC of Â£343.34 on that salary. However, most companies are entitled to an employment allowance of Â£2,000 p.a. to set against NIC due for all the employees. This means the company doesn't pay over employer's NIC until the Â£2,000 allowance is used up.

You could pay yourself a salary just under the NI threshold of Â£8,060, so you receive an NI credit towards your state pension, but you don't actually pay any tax or NI. However, at that annual salary level you will be "wasting" Â£2,540 of your tax free personal allowance, unless you have other income to cover it. The 1/9th tax credit attached to a dividend can't be repaid even if the dividend is covered by your tax free personal allowance.

Finally, don't forget your company can make contributions into your pension scheme and get a tax deduction for the cost. From 6 April 2015, if you are aged 55 or more you will be able to draw all funds from that scheme, although 75% of the fund will be taxable in your hands.

The implications of drawing funds out of a pension scheme can be complex and irreversible, so you should take advice from a financial adviser registered with the financial conduct authority (FCA) before making any decisions concerning pensions.