How to Avoid Looking Incompetent

If you are a director of a small company, then you should probably be paying yourself a basic salary to use up the personal allowance of £11,000. This is complicated by the existence of National Insurance contributions, so we advise many directors to keep the salary down to £8,116 to keep below the NI threshold. £2,884 of personal allowance is left unused unless you have other income to cover it. If you have a lot of other income, then this advice on using up the personal allowance may need to be changed. Discuss this with your accountant.

The next thing to do is to pay yourself a dividend of at least £5,000 which is tax-free (after corporation tax) unless you have other dividends, which most people don’t. We will do a round-robin e-mail in March each year to make sure all our company clients have done something here.

The next £32,000 of payable dividend would incur dividend tax at 7.5%, and dividends above that would be taxed at 32.5%. We suggest you keep dividends to the 7.5% tax band unless you really need the money.

You don’t have to pay the dividend physically. You can just leave it as a credit on your director’s loan account. You need to complete dividend paperwork which any accountant can help with – we do it on a spreadsheet system which is easy to re-use.

Now the question is, given the 7.5% dividend tax, should you avoid it by paying no extra dividend at all? Well what happens if you suddenly need lots of cash in a future year? You could end up paying a future dividend at a marginal rate of 32.% when you might have paid just 7.5% this year.

Should you take £32,000 of dividend? Well what happens if you don’t need the dividend? Then you will have paid £2,400 too much tax.

Our suggested answer to this imponderable question is that you split the difference and pay yourself dividend of £16,000 on which tax of £1,200 will be due, so you take a bit of a hit up-front. In future years you won’t look back and accuse yourself of being utterly incompetent, and maybe that is the best that can be done.

If you happen to know you will need more cash soon, for school fees for example, then vote yourself a higher dividend. Otherwise take a mid-range figure as the starting point, and see if you can identify a good reason to vary it.

If you have some scientific knowledge, you will see that this is the thermodynamic concept of equipartition in action.