How should your business owner ‘salary’ be paid?
According to job site Indeed, the average UK business owner salary is just under £38K – almost £10K more than the average for employees. That’s good news if you’re an entrepreneur, but working out exactly what you should pay yourself and how can be a tricky one.
While virtually all employees just take home a monthly payslip and have nothing more to think about, a business owner salary can be paid in a number of different ways. Working out which approach is right for you can be confusing, not to mention time consuming. But, with a little up front planning, you could potentially save yourself a lot of money.
Working out what your business owner salary should be
The beauty of starting your own company is that you get to decide what you’re worth. That said, there are some standard ways of working out roughly what you should be taking home each month which will give you greater stability.
If you’ve only just begun running your business, you need to first draw up a complete list of all your current outgoings:
- Bills and utilities
- Food, clothes and other essentials
Work out an honest picture of what you really need to get by on each month at a bare minimum. Until you start breaking even and turning a profit, you should only pay yourself this amount.
But what about once business starts coming in and you can afford a little more? You can, of course, take out all your profit on splash it on a yacht. But, it would be wiser to keep paying yourself a salary that corresponds with your ‘basic worth’. This is a common method of estimating your value as an entrepreneur, and what your business owner salary should be.
A common way of working out your basic worth involves:
- Writing down your last salary as an employee – say £25K
- Multiplying the rate of inflation by three or four (9% as of June 2017) – say 8.7%
- Adding this percentage to your previous salary – 25 X 1.087 = £27,175
Why add the inflation rate at all? Why not just keep paying yourself your market worth? Essentially, the pay ‘rise’ is a way of recognising that running a business involves extra responsibilities. Working that number out by using the inflation rate offers a more stable way of estimating your salary than just choosing a random number.
Of course, as you grow, you should pay yourself more – you deserve it after all.
How to pay your business owner salary
The way you pay yourself depends on how you set up your business: as a sole trader, as a partnership, or as a limited company. Let’s look at your options for each approach:
1. Sole trader
If you’ve decided to set yourself up as a sole trader, you’re normally free to draw as much money from the business as you want, whenever you want. This is by far the simplest way for entrepreneurs to manage their money, although it’s not necessarily the most tax efficient. You should aim to put aside at least 25% of all your earnings in a separate bank account in order to pay the tax man.
It’s sensible – though not obligatory – to pay yourself a regular salary as a Sole Trader, and reinvest the rest of the money in the business or save it for a rainy day.
Much like Sole Traders, Partnerships allow you and your partner(s) to draw as much money as you want from the business, whenever you want (after accounting for tax).
3. Limited company
As a limited company, the business owner salary must be paid through Pay as You Earn (PAYE) – you have to let HMRC know that this is what you’re doing on their website. You will then be on the company payroll – even if you’re still trading as a lone freelancer or consultant. You will be paid monthly through PAYE, National Insurance Contributions (NIC’s) start at £8,164 and income tax at £11,500.
All sound a bit complicated? Perhaps, but there are advantages, and you can potentially take home a lot more money over the course of the year than as a Sole Trader or member of a Partnership through tax efficiencies.
For example, one of the most common approaches small business owners take is to balance their salary with dividend payments. In this approach, you’d typically take home a small monthly salary, then pay yourself ‘shares’ from profits the business generates. By giving yourself a low salary and instead paying yourself Dividends from the business’s profits, you would hand over less in tax than if you paid yourself a standard salary, or the amount you pay as a Sole Trader.
Speak to an accountant for advice on the best approach in your case.
Choosing the right business owner salary approach for you
Besides the options outlined above, there are a number of other ways you can organise your business’s finances to fit around how you pay yourself. Whatever you do, you need to make sure you declare it correctly to HMRC.
For more advice on how these rules apply to you, get in touch with DSL today for guidance on the right approach for your business.