There are three ways to draw money from a limited company: director’s loan, salary, dividends. Unlike a sole trader, a director is not allowed to just take money from the company bank account.

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There are pros and cons for each way of drawing money, and in reality most directors use a combination of the three.

 

Directors’ Loan

Pros:

If the owner has put in a lot of capital in the business – cash, assets, inventory, etc., this can be accounted as a directors’ loan – loan from the Director. The director can draw money from the company without tax effect until the account becomes overdrawn.

 

If the loan is less than £5,000 and is repaid within 9 months and 1 day from the end of the accounting period, there is no tax due.

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Cons:

If the director owes more than £10,000 at any time of the year, it is treated as ‘benefit in kind’ – tax free loan to the Director. Therefore, HMRC will assume the benefit is the foregone interest. Interest will be estimated at the HMRC interest rate – 3.25% and PAYE and Class 1 NI (around 26% will be charged on the interest).

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If the loan is not repaid within 9 months and 1 day from the end of the accounting period, the company must pay 25% tax. The tax but not interest can be reclaimed when the loan is repaid.

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If the loan is written off, Class 1 NI is due on the loan amount.

 

If the company goes bankrupt, the loan must be repaid.

 

Salary

Pros:

Paying NI ensures a state pension.

Salaries and employee benefits are tax deductible, therefore there is a corporation tax saving.

Pension contributions don’t incur income tax up to a very high limit.

You need to register with the Pensions Regulator

 

Cons:

High rates of income tax (20% up to £50,270, 40% from £50,271 to £125,140, 45% above £125,140)

NI is payable up to 25% in total for employers and employees NI

 

Dividends

Pros:

Lower tax rates (effective tax rate of 8.75% for basic tax payers, 33.75% for high rate taxpayers, 39.35% for higher rate tax payer, there is a £500 tax free allowance ).

 

No NI is payable on dividends.

 

 

Cons:

Payable from profits after tax, therefore no corporation tax saving.

 

A combination of Directors’ loan, salary and dividends is usually used to draw money from the business.

For a director with no other taxable income, taking out a small salary, up to the tax free allowance of £12,570, and the rest as dividends seems optimal.