How to Pay Yourself as a Business Owner in the UK

Small business owners in the UK have a range of problems to address, among which include managing their business finances well.

Among these include the need to pay tax, managing your business expenses, dealing with cash flow and a myriad of others. Juggling so many balls in the air can feel overwhelming.

But ultimately, you’re running your own business for a healthy bottom line. Naturally, you want to benefit from your efforts. But one question that will inevitably arise along your journey is how to pay yourself as a business owner.

In this post, we outline what you need to know about this important aspect of running a business to ensure a good bottom line while reaping the rewards of your hard work. Let’s begin.

How Much Should You Pay Yourself?

A common dilemma facing many business owners is how much should you pay yourself from the earnings of your business. To answer this question is tricky and depends on the consideration of several factors. These include:

• The type of business you run (sole trader vs limited company)
• How long you’ve been running your business for
• What niche and industry it operates in
• What your bottom line looks like
• Your tax obligations
• The amount of your business expenses vs revenue vs profit
• How much you need monthly for your personal expenses
• What kind of emergency buffer you’re planning to create or have created
• The amount of tax and national insurance you need to pay 
• Forecasting and planning for upcoming business expenses and expansion costs

On average, while it is hard to give an average numerical value to how much you should pay yourself, you should consider whether your business is doing somewhat poorly over a given period, where you’ll want to take a modest pay. Alternatively, you may want to take out bonuses throughout the year for better business performance.

Your decision should keep the factors mentioned above in mind and also take into consideration any business expansion goals you may have along with personal and business expenses. Profitability should also be a strong guiding point.

How to Pay Yourself as a Sole Trader

Small business owners such as sole traders operate under the simplest business structure. As such, their profits are theirs to do with as they please. These are referred to as business drawings.

While there are some sole traders that do not separate their personal and business accounts, it’s advisable to keep one’s personal account and business account separate.

Despite the advantage that you can do what you choose with your business profits, you should be aware that you will be taxed on the total earned through the year at the end of the financial year. You will do this in your self-assessment tax return once your non-personal expenses have been deducted. That’s why it’s advisable to keep a portion of your profits for tax purposes to ensure you do not fall afoul of the law. Also worth noting is that your end-of-year tax costs are based on income tax rates and not corporation tax rates. These start at 0% and go up to 45%.

To ensure full accuracy of managing your business, you should always be able to present HMRC with a list of your:

• Business expenses
• Sales and income figures
• VAT records (if your taxable turnover is higher than £85,000 a year)

It’s also advisable to keep around 25% of your profits for taxes so that you aren’t surprised at the end of the financial year when you need to pay taxes. 

Advantages	Disadvantages
You enjoy greater flexibility in paying yourself, depending on your business’ performance	Personal assets are at risk if your business has liabilities that must be settled
	You are liable for your personal tax bill and any incorrect figures it may include

How to Pay Yourself From a Limited Company

The business structure of a limited company differs from that of a sole trader in several respects. Among these include the fact that the business owner and their personal assets are considered separate from their business assets. To pay yourself, you have several different options. Here are some you might consider:

• Pay yourself a salary: By studying industry averages and depending on your business performance, you can pay yourself a monthly salary based on the company profits generated. In such cases, you must register your company as an employer first. Once this is done, the company must deduct income tax and national insurance contributions from your salary, which is paid to HMRC via the pay-as-you-earn (PAYE) system. This will show up as an expense on your business books. However, there is a tax exemption if you pay yourself under £486 per month. When it comes to the tax free personal allowance, recent figures indicate that this is 0% up to £12,570. This means if your salary is lower than this personal allowance threshold, you won’t have to pay PAYE income tax. However, PAYE will be deducted at the following rates if this threshold is exceeded:

• 20%: For salaries between £12,571 and £50,270
• 40%: For salaries between £50,271 and £125,140
• 45%; For salaries over £125,140.

• Pay yourself a salary with a bonus: The next option you have is to pay yourself a salary as well as a periodic bonus based on the profitability of the business as well as the business income. With the limited company paying or deducting your national insurance and income tax payments as above, you may also find that paying yourself a bonus from the business’ profits is another way to pay yourself. These payments are called dividends and all profits equally must be distributed between all of the business’ shareholders. In such cases, you can enjoy more tax efficient implications due to the status of your company. The breakdown of tax you’ll have to pay on dividends include:

• The first £1,000 per annum: 0%
• Basic rate: 8.75%
• Higher rate: 33.75%
• Additional rate: 39.35%

• Pay yourself as an independent contractor: Another interesting option company owners have is to pay yourself as an independent contractor who works for the business. The company will pay you your due amount, which will be considered a part of your business costs. However, you will need to pay income tax on your self-assessment tax bill at the end of each financial year. This route is particularly useful for business owners who have a specific skill set that contributes to running the business.

Advantages of Taking a Salary	Disadvantages of Taking a Salary
Regular payments to yourself will allow you to budget better for your personal expenses.	Because you will receive a fixed wage, you will have less flexibility in adjusting your salary if your business is doing well.
It will also help you budget your business costs better.
You will not have a major tax bill at the end of the year, as taxes are deducted in advance.

How to Pay Your Tax Efficiently

First and foremost, you need to be aware that there will always be tax implicationson your business’s profits. You need to familiarise yourself with your responsibilities as a small business owner.

If you are a sole trader, you can draw on your business profits but make sure that you pay your self-assessment tax bill at the end of each year. If you are a director of a limited company, you should make sure that you fill out a personal tax return if you draw a monthly salary or are paid as an independent contractor for each tax year as well.

Ideally, it’s advisable to discuss your unique situation and tax responsibilities with a tax professional who will be able to determine your business’ net income and financial health to find the most tax-efficient way for you to take salary payments.

Your tax considerations will be tied to your business structure and you need to ensure you use a reliable payroll system that ensures greater tax efficiency so that your corporation tax and regular payment for salaries is within limits.

Common Mistakes to Avoid When Paying Yourself as a Business Owner

Whether you’re a sole trader or the owner of a limited company, there are a few common errors that are made and which should be avoided when paying your own salary. Here are some worth considering:

• Not keeping your personal and business accounts separate: It’s highly advisable that you have a separate bank account for your business and a different bank account for personal use. This will help you better determine the business and income tax payments you will have to make to HM Revenue each year. Also, by not mixing your accounts and finances, you’ll have a better idea of your business’ financial health.
• Not paying yourself at all: Not paying yourself any reasonable salary at all is an indicator that your business operations are not as efficient as they could be. You may be spending on excessive business costs while leaving your personal life in the doldrums. Consider creating a fine balance between what you earn and what you spend as a business owner on your business operations.
• Not creating an emergency fund: A further common mistake that business owners make is not creating an emergency fund. It’s always a good idea to be prepared for rainy days or challenging periods if your business is not financially stable. That’s why you should have at the very least three months worth of earnings and three months worth of salaries to pay yourself, which can go up to six months or more, if your business runs into challenges, such as the recent global financial crises.

As such, what self-employed people pay themselves will always be tied to external considerations and how much you pay depends on your business performance, business structure and your preparedness for future shocks.

How Much Do Small Business Owners Make in the UK?

Whether you take an owner’s draw or get a salary regularly at the lower earnings limit, or the company directors determine the dividends you will receive, a common question that is often asked by self-employed people is how much do small business owners make in the UK.

There is no single numerical answer to this question because there are so many factors that go into running a business, such as paying a state pension, paying other employees, the tax rates and tax returns and so much more. However, you may be guided by your own profitability to determine your own pay.

For example, when it comes to profit, Legal & General’s SME report 2019 found that 51% of businesses that are less than two years old have a net annual profit of £50,000 or less. This changes for businesses aged three to 10 years, which have an average profit of £261,000. Meanwhile, businesses aged 10 years or older turn an average annual profit of £342,000.

Conclusion

As a final word, whichever payment method you choose for yourself, make sure to choose the right payroll software to ensure greater efficiency in submitting your taxes on time and accurately. To run payroll professionally, it’s advisable to speak to a qualified and experienced accountant who will take into consideration all the sums and expenses of your business to help you determine the right amount to pay yourself from your business.

Frequently Asked Questions

What are dividends classed as?

In short, dividends are classed as personal earnings. Directors often pay themselves a salary at the lowest limit below the tax threshold and then take dividends to make up the remainder of their earnings, which are taxed at a lower rate.

How much should you pay yourself as a business owner?

This will greatly depend on the nature of your business and your business earnings. However, always ensure that you factor in your business expenses, have a separate fund for challenging times and also set aside some of your earnings to reinvest in the business for continued growth and prosperity.

What are common business expenses?

Common business expenses include payroll (such as wages, employee benefits and employer taxes), cost of goods sold, repayments (e.g. business loans with associated interest), marketing and advertising, rent or lease costs, utilities like electricity and gas as well as investment for growth.