Most tax-efficient way to pay yourself

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Introduction   

What should we contemplate when considering how to be tax-efficient (UK) as a contractor? Tax benefits are available when you operate independently with your company but not when employed. Many will ask if I should pay myself a salary or dividends, which requires careful thought. When running a limited company business, you can take your income as a mixture of dividends and salary. Besides your overall contractor tax rate, an initial thought is, what is the most tax-efficient way to take money out of a company? Also, when running a UK contracting business, what is the most tax-efficient way to pay yourself in 2024/25? These are common thoughts for many contractors. In summary, it’s key to consider limited company tax efficiency (UK) when considering your take-home pay 24/25.

Your income tax rate for contractors will vary depending on your level of taxable income. In the UK, there is the basic rate (BR), the higher rate (HR) and an additional rate tax. When you’re a UK contractor, if you can achieve the most tax-efficient remuneration mixture of dividends and contractor salary 2024/25, it ensures your overall contractor’s tax rate is no higher than it needs to be. Therefore, we’ll look at tax rates for contractors and, determine what is the most tax-efficient way to pay yourself and consider the options available. Furthermore, if you’re moving into contracting and want to see how much more tax-advantageous this is, you could look online for a Contractor vs Employee salary calculator (UK).

Initial thoughts on the most tax-efficient way to pay yourself

How to be tax-efficient & reduce contractor taxes? 

As an individual, you may look to make the most of your personal savings. This could be in the form of an account with a reasonable interest rate. Similarly, you may look to make savings on your outgoings. Indeed, this could be by getting good deals on your household bills and lifestyle costs. Importantly, you can choose what you pay yourself when you own your company. As a result, there’s no reason why you should consider paying yourself tax efficiently and, as a result, reduce your contracting tax on the income you take from your business.

As a contracting professional, you must consider how you pay yourself as a business owner (UK) when you run your own UK company. When you’re a contractor paying yourself from a limited company, you should give this some thought. With your own contractor limited company, you have the option of paying yourself dividends. On the other hand, when you’re a sole trader or self-employed, this isn’t an option. Therefore, it’s good you have some flexibility when paying yourself from your business (UK).

How do we gain tax efficiency?

When contracting, it’s good to consider what you can do to gain tax efficiency (limited company and personally). Indeed, that’ll be by minimising your contractor rates of tax:

  • Make day-to-day savings through your business and, as part of this, maximise your company profit.
  • Find the best way to pay yourself as a director from your business. Indeed, you’ll aim to maximise your take-home pay as a company director. As a result, you can pay yourself more. Therefore, owning your company enables you to combine dividends and salary. As a result, you can use the most tax-effective way to pay yourself.

This guide will examine the best way to pay yourself from a small business and research how to become more tax-efficient. Indeed, this includes looking at limited company tax efficiency for high earners (UK). Also, as a limited company contractor, we’ll look at what to consider in terms of your UK contractor tax rate and tax efficiency in the 2024/25 tax year.

How do you make savings personally & as a business?

When you want to save money personally, it’s good to reduce your spending. On the other hand, when you’re running a business, it’s good to reduce your tax bill:

  • As an individual, you could shop around in terms of what you buy. Secondly, you can put your savings into a Cash ISA or stocks and shares ISA. The ISA allowance 23/24 and 24/25 is £20,000, unchanged from 22/23. There is also a new British ISA allowance of £5,000 from 24/25 onwards, in addition to the existing ISA allowance. It provides a savings opportunity for individuals to invest in the United Kingdom while supporting UK companies.
  • As a business owner and limited company director, you can look for ways to improve tax efficiency (UK). Therefore, you can look to make savings on what your company buys. As part of this, it can save on taxes by claiming all its valid tax-deductible business expenses. Moreover, when you claim for all valid costs, it reduces the company’s tax liabilities. Indeed, if you claim all valid business costs, this helps to improve your overall contractor tax rate. Another way to save tax through your company is to ensure you pay yourself tax efficiently.

Further initial thoughts

This guide will examine how to operate with limited company tax efficiency. We’ll examine the historical and current tax allowances and the tax bands 24/25. This will involve researching the UK tax and NI thresholds 24/25 and seeing how these interact with your income. What’s more, we’ll look at how to extract profits on a tax-efficient basis when running your own business. Further, we’ll research how to pay less tax as a limited company and how to save tax as a contractor.

This guide has helped plenty of UK limited company contractors understand how to be tax-efficient. When you have a good contractor accountant, they’ll help to guide you here. One of our handy tax tips for UK contractors and small business owners is how to pay yourself tax efficiently.

Common questions on the most tax-efficient way to pay yourself

Those who work for themselves will likely have questions about tax-efficient ways to pay directors. Such questions could include the following:

  • How do you pay yourself as a limited company?
  • How much dividend can I pay myself tax-free?
  • What are the UK tax bands?
  • How do you pay yourself from a limited company (UK)?
  • What is the basic rate of tax (UK)?
  • How do you pay yourself dividends?
  • Should I pay myself in dividends or salary?
  • How much is the basic rate tax?
  • How to work out take-home pay?
  • What is the higher rate tax band?
  • How to reduce taxable income (UK)?
  • How do you save tax in the UK?

This guide will cover the above regarding tax efficiency and examine the history of UK tax bands. We’ll also look at the current UK tax bands and how tax works in the UK.

Further initial thoughts 

What is the most tax-efficient way to pay yourself as a director?

First, how to maximise your pay and operate as a tax-efficient limited company contractor isn’t always well understood. Therefore, you should consider how to pay yourself as a contractor. When you do this, it helps improve your overall contractor income tax rate.

Second, when an accountant takes on new clients, operating with tax efficiency is something they don’t always fully understand. On many occasions, their previous accountant didn’t explain this to them very well. What’s more, the method for working this out isn’t too awkward if you have the correct information to hand.

In conclusion, once you’ve read this through, you should be aware of the following:

  • The best way to pay yourself tax efficiently via your UK limited company in 2024/25. This includes the tax-efficient ways to take money from a company.
  • How you can maximise your basic rate tax band 2024/25. When you know this, you’ll be aware of how much I can earn before paying higher rate tax.
  • How much should contractors save for taxes when they pay themselves from their companies? When we ask how to save tax as a contractor, you should always save your personal tax safely in a personal savings account. You can pay this to HMRC once it becomes payable.
  • How to operate with tax efficiency when running your own UK business. This can help improve your contractor tax rate.

Financial year & tax year

The calendar year runs from 1 January to 31 December.

Your UK contracting company’s financial year starts from the first day of your accounting period. On the other hand, if it’s your first year, the start date is your company’s incorporation date. The financial year will run to your company’s year-end date in both cases. Therefore, if your company was incorporated on 15 July 2023 and your company year-end is 31 July 2024:

  • The accounting period in year 1 will run from 15 July 2023 to 31 July 2024.
  • In year 2, it will run from 1 August 2024 to 31 July 2025.

The UK tax year runs from 6 April to 5 April. Therefore:

  • The 2023/24 tax year ran from 6 April 2023 to 5 April 2024.
  • In 2024/25, the tax year will run from 6 April 2024 to 5 April 2025.

Tips & advice 

What is the most tax-effective way to pay yourself as a contractor? 

If you’re new to running your own company, there are many things to consider. A good tip on how to reduce tax as a contractor is to claim all your genuine business expenses. As we mentioned earlier, this helps improve your contractor tax rate. This is because the tax your company and you pay, compared to the original contracting income earned, is lower when you claim all valid expenses. Indeed, it helps if you claim all your costs each financial year, and they include:

  • Rechargeable expenses to your client.
  • Non-rechargeable expenses.

Expenses help to lower your company’s profit. This results in a lower Corporation Tax bill and more post-tax profits. More profits result in more funds available to you as dividends.

Salary payments are business expenses that help reduce your company’s profit and tax. Therefore, you should consider your salary level from the outset. Furthermore, you can consider employing your spouse if they’ll be helping you run your company.

Besides taking a salary, you can take tax-efficient dividends from your company. In turn, this helps decrease your contract tax rate in terms of tax efficiency. Therefore, when you have this choice, is it better to pay yourself a salary or dividends? In this guide, we’ll consider this; however, before we move on, there are several aspects regarding paying dividends. These include:

How to gain tax efficiency & improve contractor tax rate? 

One thing which does come up quite often from company directors is:

  • How I can operate with limited company tax efficiency.
  • What’s the best way to take money from a UK limited company?

To work the above out, first, you should know:

  • What are the current tax bands (UK) and allowances?
  • How the above will interact with taxable income.
  • What are the current tax rates?
  • How the above is applied to different sources of income.

To summarise, tax rates, bands and allowances change over time. As a result, these all affect your contractor’s rate of tax. Therefore, when you operate and pay yourself with tax efficiency and improve your contractor tax rates, you should know how your tax bands work and how your income is taxed each tax year. As a result, this will show you how much tax you pay as a contractor.

Recent UK tax changes 

In this guide, we’ll examine how to pay yourself tax-efficiently and make the maximum use of your BR tax band. However, we’ll also examine some recent UK tax allowance changes.

First example

One recent change were some contractor tax changes 2016. This involved the complete overall of the UK dividend system. Before April 2016, the dividend individuals received was 9/10ths of the gross. As part of this, they received a 10% tax credit. Dividends were taxed 0% in the basic rate tax band and 25% in the higher rate tax band. Also, they were taxed at 30.56% in the additional rates band. However, in April 2016, the government altogether scrapped this. Instead, they brought in the tax-free dividend allowance of £5,000. Also, the higher rate tax band dividend increased to 32.5%. This was later increased to 33.75% in April 2022.

This £5,000 dividend allowance stayed in place for 2016/17 and 2017/18. In the next tax year, in 2018/19, the government reduced this allowance to £2,000. It stayed at this level until 2022/23. However, the dividend allowance in 2023/24 decreased to £1,000; in 2024/25, it is now £500.

Second example

A further example of a recent change is for bank interest income before April 2016. Before this, interest income was taxed at source (20%). However, after April 2016, you now receive interest tax-free but:

  • Basic rate band (20%) taxpayers can earn £1,000 interest per year with no tax. Therefore, this gives a maximum tax saving of £200 compared to the time before.
  • Higher rate band (40%) taxpayers can earn £500 interest per year with no tax. Therefore, this gives a maximum tax saving of £200 compared to the time before.
  • Additional rate band (45%) taxpayers can earn £0. I.e., they don’t receive a tax allowance for their interest.

Brief history of UK tax rates & bands 

First thoughts

The personal tax allowance and BR tax band usually change annually.

The personal tax allowance is the income you can earn before paying income tax.

The BR band is the income you can earn in addition to your personal allowance, subject to the BR tax rate.

Most importantly, the standard personal allowance has been increasing over recent years. Meanwhile, the BR band has been increasing too. However, this wasn’t always the case, as is shown below. However:

  • In recent tax years in the UK, there have been different allowances and tax rates in Scotland. Wales and Northern Ireland have their own tax allowances and tax rates, which align with those of England.
  • A few years ago, the government introduced separate rates and tax bands for savings. If you have sizeable savings, you should take these into account.

Most tax-efficient way to pay yourself -historical personal allowances & tax rates 

Let’s look at the historic UK tax brackets to see how they’ve changed over time. Therefore, the recent personal allowance and UK tax bands are as follows:

Personal allowance Basic rate tax Higher rate tax Additional rate tax
20% 40% 45%
2024/25 £12,570 £0 – £37,700 £37,701 – £125,140 £125,141
2023/24 £12,570 £0 – £37,700 £37,701 – £125,140 £125,141
2022/23 £12,570 £0 – £37,700 £37,701 – £150,000 £150,001
2021/22 £12,570 £0 – £37,700 £37,701 – £150,000 £150,001
2020/21 £12,500 £0 – £37,500 £37,501 – £150,000 £150,001
2019/20 £12,500 £0 – £37,500 £37,501 – £150,000 £150,001
2018/19 £12,500 £0 – £34,500 £34,501 – £150,000 £150,001
2017/18 £11,850 £0 – £33,500 £33,501 – £150,000 £150,001
2016/17 £11,500 £0 – £32,000 £32,001 – £150,000 £150,001
2015/16 £11,000 £0 – £31,785 £31,786 – £150,000 £150,001
2014/15 £10,600 £0 – £31,865 £31,866 – £150,000 £150,001

Blind persons allowance

Under the UK tax rules, a blind person receives an extra tax allowance, and this is:

2024/25 £3,070
2023/24 £2,870
2022/23 £2,600
2021/22 £2,520

The most tax-efficient way to pay yourself -current allowances & future thoughts

In 2024/25, the total you can earn, which is the earnings limit before paying tax as a contractor, is your personal allowance of £12.570. The UK basic rate tax band is £37,700, and adding this to the personal allowance totals £50,270. This is the income limit before you start paying tax under the higher rate tax bands.

As shown above, the income tax rates for the basic rate band of 20% and the higher rate band of 40% have been consistent over recent tax years. These rates apply to earned income (salaries, self-employment profits, etc.). The tax rates that apply to dividends are different because dividends fall under the investment income category.

The personal tax allowance and BR tax band will continue to evolve. Knowing what you can earn to maximise your BR tax band is very useful when running your business. As part of this, you’ll learn what tax you must pay in the future. In addition, we’ll look at how you can pay yourself tax efficiently and lower your overall contractor tax (UK).

The most tax-efficient way to pay yourself as a contractor in 2024/25 

First considerations 

When you consider the most tax-effective way to take money from a company, you could take the full £50,270 basic rate (UK) earnings in 2024/25 and stay within your BR band. However, your company should be earning enough profit to be able to pay you the £50,270.

As mentioned, the maximum an individual can earn in 2024/25 before paying higher rates tax is £50,270. There are, however, certain tax reliefs which can reduce your taxable income (this effectively means your total income before any reliefs could be higher than £50,270), and these are namely:

  • Donations under Gift Aid.
  • Personal pension contributions.
  • Investments under Venture Capital Trust schemes (EIS, SEIS, and SITR).

If you earn £60,000 and have combined tax reliefs of £10,000, your taxable income is £50,000. As a result, your total income is in the BR tax band. Therefore, in this example, you could take £60,000 as income and still be in basic rate tax (UK).

To sum up, when you run your own business, you can take your earnings as a combination of salary and dividends. This blend of income is the current most tax-effective way to pay yourself. When you’re employed, you don’t have this option.

Most tax-efficient way to pay yourself -what is a UK contractor’s suggested salary level? 

When considering what is the most tax-efficient way to pay yourself and, as part of this, when maximising the take-home pay and minimising your overall contractor tax rate, you could:

  • Pay yourself a contractor tax-efficient salary of £12,570 (the same as the personal allowance) per annum. This basic rate pay is the most tax-efficient salary (UK) if you don’t have any substantial income from other sources. Also, this salary level is enough to count as a qualifying year for NI credits for UK state pension purposes. The £12,570 is a tax-efficient salary for directors 2024/25, equating to £1,047.50 per month. With the most tax-efficient director’s salary 2024/25 set at this level, the director/employee will pay a small amount of employees’ National Insurance contributions (NIC). In contrast, the employer pays a minor amount of employer’s NIC. However, in 2024/25, it’s only more tax effective to take a contractor tax-efficient salary 2024/25 of £12,570 per annum if you don’t have other income, i.e. rental, self-employment or pension income, etc, which uses up your personal allowance.
  • In addition to your basic rate salary, your company makes dividend payments of £37,692, which equates to a monthly dividend of £3,141. Alternatively, your company could make higher dividend payments if you take a lower director’s salary of 24/25.

Result

Adding the annual salary and dividend together would give just under £50,270 in total earnings. This combination of salary and dividends is the most tax-efficient if you have a business and your total income is just under £50,270. As a result, your overall contractor tax rate is lower than if you’d taken a higher salary level.

Most tax-efficient way to pay yourself as a director & tax allowances 

UK tax allowances 

When looking at how to maximise your tax allowances, the personal tax allowances available to you are as follows:

  • Your tax-free personal allowance 24/25 is £12,570.
  • Your dividend tax-free allowance 24/25 is £500.

There is an option to claim part of your married couple allowance if you’re married or in a civil partnership. This isn’t available for everyone and is only beneficial if one partner is a basic rate taxpayer and the other doesn’t use up their personal tax allowance (£12,570 pa). Therefore, the BR taxpayer must have earnings under the UK higher rate tax band (£50,270 pa) to qualify for the marriage allowance claim.

How to work out tax & limited company take-home pay? 

When you pay yourself tax efficiently and maximise your basic rate tax band, you can consider which tax bands cover which types of income. Therefore:

  • Your personal allowance covers the £12,570 salary we show above.
  • First, you should take your personal allowance of £12,570. Next, deduct the £12,570 above, resulting in £0.
  • Finally, take the dividend figure above of £37,692 and deduct £0 of personal allowance left and the £500 dividend allowance this leaves £37,192 taxable dividends. Therefore, multiplying this by the UK basic rate of tax on dividends (8.75%) gives £3,254.
  • In conclusion, the tax-efficient result is that the tax you pay as personal tax is £3,254 out of income, totalling £50,262, leaving a contractor take-home pay of £47,008. You’ll pay the tax via your Self-Assessment tax return later. As shown in the example above, your overall contractor tax rate is less than if you’d paid a higher salary.

Most tax-efficient way to pay yourself -what are the monthly earnings & tax savings? 

When you look at how to operate with limited company tax efficiency, as shown in the scenario above, this will result in:

  • First, you can take a monthly salary from the company bank account of £1,047.50.
  • Second, your monthly dividend from the company account is £3,141.
  • You must save £3,254 divided into 12 = £271.17 per month to cover your personal tax, which is payable to HMRC later. Personal tax is payable to HM Revenue & Customs via your Self-Assessment Tax Return.
  • In short, £1,047.50 plus £3,141 minus £271.17 = £3,917.33 net earnings each month (£47,051 per annum) -you’ve maximised your BR tax band.
  • To summarise, this will leave the director’s gross income just beneath the BR rate tax band of £50,270 pa.

One key aspect you should consider is if you’ve any other taxable income. Such income could include property income, bank interest, other dividends, capital gains transactions, etc. If you do, you might consider a lower monthly salary, such as above the Lower Earnings Limit (LEL) of £533 per month for 2024/25. The Secondary Threshold (ST) starts at £758 per month, while the Primary Threshold (PT) starts at £1,048 per month, as highlighted above. A salary under £1,048 per month won’t incur employees NI; however, employer’s NI begins at £758. For a more in-depth view of salary considerations when you run your UK company, please read our guide on contractor salary.

More thoughts on the most tax-efficient way to pay yourself 

Do you have income from other sources? 

When considering the most tax-efficient way to take money from a company, you may have other taxable income. Such income could include rental profits, bank interest, or other dividends. Therefore, any other income must be considered when working out how to pay yourself as a business owner tax efficiently.

Higher rate tax band (UK)

You can maximise your BR tax band as described above; however, if you, as an individual, personally earn more than £50,270 in 2024/25:

  • Dividends which fall in the higher tax band (UK), i.e., above £50,270, are taxable at 33.75%.
  • If you earn above £100,000 as your personal taxable income, you start to lose your personal allowance the more you earn. You’ll effectively lose £1 or your personal allowance for each tax-adjusted £2 of income you earn above this.
  • When you earn more than £125,140, you’ll be one of the additional 45% tax band taxpayers in the UK. Therefore, you’ll pay tax at the additional rate tax band, which is currently 39.35% on dividends.

Director’s loans 

Besides repaying expenses and net salaries, other withdrawals are usually classed as dividends when you take money from your company. When we consider how to pay yourself on a tax-efficient basis, another consideration is to take a temporary loan from your company. If you require income that is more than what is shown in the tax-efficient example above, you could treat any excess as a payment to your director’s loan account. This will be a temporary loan to the director (you); however, you must ensure you repay this in the future. In addition, when you have a director’s loan, there may be two potential tax implications, depending on how much you borrow and how long you borrow it.

Final thoughts 

This guide shows how to be tax-efficient in 2024/25 and how to maximise your basic rate tax band as a UK contracting professional. It also explains how to be tax-efficient (UK) as a contractor or limited company owner. Those who work for themselves can use their personal tax bands. Basically, these are some of the best things to do, financial-wise. Indeed, it’s a good idea to minimise tax in the higher tax band when you can.

If you follow the advice in this guide regarding claiming all genuine costs and setting your salary efficiently, you’ll improve your contractor tax rate. However, you must do further workings to help you decide on the most tax-efficient way to pay yourself from a company if you have any sizeable other income sources.

If you live in Scotland and are subject to the Scottish tax bands, there could be other areas to consider.

In the future, we’ll update this guide to show how you can operate with limited company tax efficiency. This will occur when the UK tax allowances, tax bands and rates change.

And finally…

Besides showing how you can calculate the what is the most tax-efficient way to pay yourself, there are many other good reads for UK contracting professionals on this contractor website. These cover salary, paying your spouse, dividends, expenses, company profit, etc. They also demonstrate how you can run your company with tax efficiency, lower your overall contractor tax rate, save tax as you go along and what to watch out for when running your contractor business.

Finally, you may be interested in pension consolidation if you’ve previously worked at several employers and have various pension schemes dotted around.

Link to Contractor Advice UK group on

LinkedIn    https://www.linkedin.com/groups/4660081/

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