Deciding a salary as a contractor will affect Income Tax and National Insurance payments. This guide provides key information so you can decide what contractor salary is best for your circumstances.
As accountants, we can’t tell you what to pay yourself but we can ensure that you have the facts you need to make an informed choice. Setting your contractor salary for the current tax year can be daunting, but by exploring the options you can make the right decision for your needs.
It’s worth being aware that there is no minimum wage requirement if you are a director of a company unless you have a contract of employment with your company. Typically a director / contractor deciding on their salary would take one of four 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
- Taking a higher salary to satisfy visa or lending requirements
If you are within / caught by IR35 legislation all earnings will be classed as salary and dividends cannot be paid. If you are an inniAccounts client any of your contracts are inside IR35 please let your Account Manager know so we can provide further assistance.
Deciding what’s right for you
There are a number of questions you should ask yourself and consider when deciding on your salary:
- 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?
- Do you have 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. The rates, bands and options are discussed below.
Income tax rates in 2024/25
The rates and bands below for Income Tax are for an individual with a personal allowance of £12,570:
| Income per year | Rate (salaries) | |
|---|---|---|
| Tax free | £0 – £12,570 | 0% |
| Basic rate | £12,571 – £50,270 | 20% |
| Higher rate | £50,271 – £125,140 | 40% |
| Additional rate | Over £125,140 | 45% |
The tax-free personal allowance for 2024/25 is £12,570, therefore, a salary up to this threshold will be free of Income Tax.
Please note, income tax rates and bands are different for Scottish taxpayers. You can find more information on Scottish PAYE tax codes and rates here.
National Insurance thresholds in 2024/25
When an individual is paid a salary more than the thresholds below, employers and employees NICs are payable.
| For employees | For employers | |
|---|---|---|
| Weekly pay | £242.00 | £175.00 |
| Annual pay | £12,570.00 | £9,100.00 |
To continue to qualify for the state pension and to retain entitlement to benefits, a salary of at least £6,396 must be earned. Once a salary exceeds £9,100 National Insurance deductions start.
Dividend tax rates in 2024/25
Although not related to choosing a salary, it’s important to be aware of dividend tax.
| Rate (dividends) | |
|---|---|
| Dividend allowance £500 | 0% |
| Basic rate band | 8.75% |
| Higher rate band | 33.75% |
| Additional rate band | 39.35% |
There is a £500 dividend allowance which means the first £500 of dividends issued will be free of Income Tax. The tax rates on dividends issued above £500 will depend on the bands they fall into. Any tax that becomes due on dividends will be calculated and paid through Self Assessment.
Pension contribution considerations
It’s important to plan for retirement and to be sure you understand the rules around pensions and contributions. As accountants, we are not authorised to advise on pensions, therefore, we recommend seeking advice from an Independent Financial Advisor.
By setting your salary you also set the maximum personal contributions you can make into a personal pension. If you want to supplement these payments, you may be able to make employer contributions for Directors to top up your pension – remember to always check your pension provider allows this first.
There is an annual maximum of £60,000 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.
Demonstrating income levels
You may want to consider taking a higher salary in order to satisfy visa or lending requirements where a minimum salary level is required.
The majority of lenders are becoming more flexible in terms of how you demonstrate your income. More lenders now consider dividend income in addition to traditional salary income when calculating total income for borrowing. It is always worth exploring the opportunities as this may mean you can maximise tax efficiencies by reducing your salary.
Taking all income streams into account
When you are calculating your tax and NIC liabilities, it is important to ensure that you consider all your income streams. This can include salary or income from other jobs, share and savings income, pension income and any other source of income.
Summary – all the key figures in one place
Below you’ll see a handy infographic that summarises the key points to consider when setting your salary for 2024/25. This graphic is based on a £12,570 personal allowance.
