Salary vs Dividends: How You Should Pay Yourself

As a business owner, one of the most important decisions you will make is how to pay yourself. There are several options available, including paying yourself a low salary and high dividends, paying yourself a higher salary, or a combination of the two. In this article, we will explore the pros and cons of each approach to help you decide which option is best for you.

Low Salary and High Dividends

Paying yourself a low salary and high dividends is a popular option for many business owners. Dividends are payments made to shareholders from the profits of the business, and they are taxed at a lower rate than salary. This can result in significant tax savings for business owners.

Advantages

One advantage of this approach is that it can help to reduce the overall tax burden for both the business and the owner. It can also provide flexibility in terms of when and how much you pay yourself, as dividends can be paid out at any time and do not have to be a fixed amount.

Disadvantages

However, paying yourself a low salary can have some downsides. It may affect your ability to qualify for certain benefits, such as a mortgage or a personal loan, as your income may appear low on paper. It can also limit your ability to save for retirement, as your salary is the basis for determining your contributions to a retirement plan.

Furthermore, if your business is struggling or not generating significant profits, paying yourself high dividends may not be sustainable in the long term. It is important to ensure that your business has a strong financial foundation before deciding to pay yourself high dividends.

Higher Salary

Paying yourself a higher salary can also have advantages and disadvantages. One advantage is that it can provide you with a steady, reliable income that is not dependent on the performance of your business. This can be particularly important if your business is still in the early stages and not yet generating significant profits.

Advantages

Additionally, a higher salary can help you qualify for various benefits such as mortgages and personal loans. It can also allow you to contribute more to a retirement plan, helping you to build a stronger financial foundation for the future.

Disadvantages

However, paying yourself a higher salary can result in higher taxes and can also reduce the profits of your business. This can be particularly problematic if your business is struggling or not generating significant profits. In such cases, a higher salary can put additional strain on your business and may not be sustainable in the long term.

Combination of Salary and Dividends

A combination of salary and dividends can offer the best of both worlds. This approach allows you to take home a reasonable salary while also receiving some of the benefits of paying yourself dividends.

Advantages

For example, you can pay yourself a salary that is high enough to qualify for benefits such as mortgages and personal loans, while also paying yourself dividends to take advantage of the lower tax rate. This approach can also provide flexibility in terms of how much you pay yourself in each category, depending on the financial performance of your business.

Disadvantages

One disadvantage of this approach is that it can be more complex to manage and may require more administrative work to ensure that you are complying with tax laws and regulations. It can also be more difficult to predict your income and plan your finances when your income is split between salary and dividends.

So how much should I pay myself as a business owner?

Ultimately, the approach you choose will depend on your individual circumstances, financial goals, and the performance of your business. It is important to work with a financial advisor or accountant to determine the best approach for you and to ensure that you are complying with all tax laws and regulations.