Contractor Salary: How to choose a Tax-Efficient salary

 

How to choose a Tax-Efficient salary in 2018/19

As a director of your own limited company you need to decide how you wish to extract funds from your company. This will include annually reviewing the level of salary you wish to pay yourself.

As your accountant we cannot tell you what to pay yourself but we can make sure you have all the information you need to hand. The salary you set will affect your Income Tax and National Insurance payments so it’s important you understand all the implications.

Before we get into detail it is worth remembering that if your contract is caught by IR35 legislation all your earnings will be classed as salary and dividends cannot be paid. The rest of this guide will then be less relevant.

So assuming you are outside IR35, as a director, you don’t have a contract of employment with your Limited company and so there is no minimum wage requirement. This means you can choose to pay yourself any level of salary you see fit.

Contractors typically decide on their salary based on one of three approaches:

  • Maximising tax and National Insurance Contributions (NICs) efficiencies; or
  • Meeting the Income Tax threshold; or
  • Paying themselves a living wage based on their specific needs or a salary to support VISA or lending requirements

How to decide what is right for you

There are a number of considerations when deciding on your salary, including:

  • What income tax and NICs efficiencies do you want to achieve?
  • Do you want to ensure that you retain your right to a state earned pension and other benefit entitlements?
  • What level of contribution do you want to set for your pension this year?
  • Do you need to demonstrate a certain salary level for any reason e.g. income for borrowing purposes?

When calculating your potential tax and NIC liabilities it is important to take all your income streams into account. This can include salary or income from other jobs, share and savings income, pension income, rental income and all other sources of income.

Income Tax and NIC efficiencies

Salaries paid are subject to Pay As You Earn (PAYE) Income Tax and National Insurance deductions at the following rates for 2018/19:-

Income tax rates

The rates and bands below for Income Tax are for an individual with a personal allowance of £11,850:

 

Income per year

Rate (salaries)

Tax free

£0 – £11,850

0%

Basic rate

£11,851 – £46,350

20%

Higher rate

£46,351 – £150,000

40%

Additional rate

Over £150,000

45%

The tax-free personal allowance for 2018/19 is £11,850, therefore, a salary up to this threshold will be free of Income Tax (but NIC will be payable at this level).

National Insurance thresholds

When an individual is paid a salary more than these pay period thresholds, employers and employees NICs are payable.

 

For employees

For employers

Weekly pay

£162.00

£162.00

Annual pay

£8,424.00

£8,424.00

To continue to qualify for the state pension and to retain entitlement to benefits, a salary of at least £6,032 must be earned. Once a salary exceeds £8,424 National Insurance deductions start.

If you employ staff, other than yourself you may benefit from the Employment Allowance which can save you the first £3,000 of Employers National Insurance contributions.

Dividend tax rates

If you are outside IR35 and able to take dividends as well as salary, it is important to understand the dividend tax rules as you will be planning for your overall tax liabilities.

 

Rate (dividends)

Dividend allowance £2,000

0%

Basic rate band

7.5%

Higher rate band

32.5%

Additional rate band

38.1%

The first £2,000 of dividends will be free of Income Tax but the tax rates on dividends above £2,000 will depend on your overall income and the bands they fall into. Any tax that becomes due on dividends will be calculated and paid through Self-Assessment.

Pension contribution considerations

Retirement planning is important for a lot of contractors. The salary you set will also set the maximum contribution you can make into a personal pension. If you want to supplement these payments, you may be able to make employer contributions from your Limited company but we advise that you check first with your pension provider.

There is an annual maximum of £40,000 for tax-free pension contributions as long as you were in a registered pension scheme during the tax year. You may also be able to top up your pension for the current tax year with any allowance you didn’t use from the previous 3 years. This would, however, be limited to your Net Relevant Earnings (NRE) which excludes dividend income.

As accountants, we are not authorised to advise on pensions, therefore, we recommend seeking advice from an Independent Financial Advisor. We partner with Contractor Wealth who are able to provide all the pensions advice you need – just ask us to refer you!

Demonstrating income levels

You may need to take a higher salary in order to satisfy visa or lending requirements where a minimum salary level is required although more lenders are becoming more flexible in terms of how you demonstrate your income and many will now consider dividend income in addition to traditional salary income when calculating total income for borrowing. Our partners CMME can advise on obtaining mortgages and loans based on non-traditional salary evidence and it is well worth discussing. You need to be sure that when determining salary you balance tax efficiencies with the ability to obtain funding if needed.

So to summarise….

We have said a lot about what you should consider when choosing your salary, so to summarise here are the tax and NIC implications of the most common options taken by contractors.

For more information on deciding between salary and dividends, read here. 

Why Orange Genie Accountancy?

Orange Genie Accountancy offers fixed fee accountancy packages to contractors and freelancers. Each client has unlimited access to their own dedicated approachable and friendly accountant. All Orange Genie Accountancy accountants are specialists in the contracting market, so they can give you bespoke, high quality advice.

We will always keep you informed about anything that could affect you and your company. Our relationships with our clients are extremely important to us so we'll be in touch often, whether it be face to face, over the telephone or email.

Our packages start at £75 + VAT a month for an online service. Our most popular package is £120 + VAT a month which provides you with your very own dedicated accountant as well as:

  • Unlimited accountancy support
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  • Proactive contact
  • Director and employee payroll
  • Annual Return
  • Self-Assessment Return
  • A fully compliant service so you are safe in the knowledge that you are meeting your legal obligations
  • Access to the OG Connect, which is updated in real time so you can always see how your business finances are looking

​And much more, includingaccess to wealth management advice, IR35 reviews and pensions planning. 

If you would like to appoint Orange Genie Accountancy as your accountants please either fill out our enquiry form or give one of our friendly expert accountants a call on 01296 468 185 or email accountancy@orangegenie.com

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