Optimal Salary Level

When deciding on what level of salary to pay, it is important to remember that while there are some general rules, there is no “one size fits all”. Assuming that the director’s personal allowance is available and not otherwise utilised, the optimal salary will depend on whether or not the employment allowance is available. The employment allowance is set at £4,000 for 2021/22 and, where available, will shelter employer Class 1 NICs, which would otherwise be payable up to this level. However, not all companies can benefit from the allowance, and it is not available if the company is a personal company where the sole employee is also a director.

Employment allowance not available

The maximum salary that can be paid free of tax and National Insurance if the director is aged 21 or over and the Employment Allowance is not available is one that is equal to the secondary threshold of £8.840. This is equivalent to a salary of £737 per month.

Employment allowance available

Where the employment allowance is available it can be beneficial to pay a salary above the primary threshold. If the personal allowance is not used up elsewhere (for example, by rental or investment income), for 2021/22 it can be advantageous to pay a salary equal to the personal allowance of £12,570.

Paying a salary in excess of the personal allowance

Is it worth paying a salary higher than one equal to the personal allowance of £12,570? The answer will depend on the amount of profits to be extracted, whether the employment allowance is available, whether the director is entitled to other allowances, such as the blind person’s allowance or the married couple’s allowance, and the director’s marginal rate of tax. There is no substitute for doing the sums.

Generally, however, where the salary exceeds the personal allowance, any further salary will suffer tax at the basic rate (at 20%) and employee’s National Insurance (at 12%), even if no employer’s National Insurance is due.

The combined tax and employee National Insurance hit at 32% is more than the associated Corporation Tax saving (at 19%), so once this level is reached, other extraction methods may be preferable to take advantage of allowances and lower tax rates.