How Do I Know If I Am Paying Myself Tax Efficiently

At Towerstone Accountants we provide specialist small business accountancy services for owners, directors, and growing businesses across the UK. We created this webpage for small business owners who want clear guidance on managing finances, meeting tax obligations, and making informed decisions without jargon. Our aim is to help you stay compliant, improve cash flow, and build a more resilient business.

This is one of the most important questions any business owner can ask and it is one I am asked almost every week. Whether you are self employed a company director or running multiple income streams the way you pay yourself has a direct impact on how much tax you lose unnecessarily and how much you keep.

In my experience most people are not deliberately inefficient. They are simply unsure. They take money out when they need it assume the tax will sort itself out later and only really look at the numbers once a year. By that point the opportunity to plan has already passed.

Tax efficiency is not about avoiding tax or using aggressive schemes. It is about understanding the rules and using them properly. The UK tax system gives you options. The challenge is knowing which option applies to you at the right time.

In this article I want to explain clearly how you can tell whether you are paying yourself tax efficiently. I will walk through the main structures how income is taxed common mistakes I see and how an accountant helps you optimise what you take home legally and sensibly. This is written from first hand experience working with UK business owners across many sectors.

What paying yourself tax efficiently actually means

Tax efficiency does not mean paying the least tax possible at all costs. It means paying the right amount of tax based on your circumstances without overpaying or triggering avoidable charges later.

When I review a client’s situation I am looking at several things at once:

• The total tax paid across income tax National Insurance and corporation tax

• The timing of tax payments and cash flow impact

• Whether allowances and thresholds are being used properly

• Whether the structure matches the size and stability of the business

• Whether today’s decisions create problems tomorrow

Someone can pay very little tax one year but create a much bigger bill the next. That is not tax efficient. Efficiency is about balance sustainability and clarity.

The first thing to understand is how you are structured

Before you can judge whether you are paying yourself efficiently you need to be clear on how your business income is taxed. This depends entirely on your structure.

The most common structures I see are:

• Sole trader or self employed

• Limited company director shareholder

• Partnership or LLP

• Mixed income from employment property or dividends

Each of these is taxed differently and the way you pay yourself must match the structure. Comparing yourself to someone in a different setup almost always leads to confusion.

For example what is tax efficient for a limited company director is often completely wrong for a sole trader.

If you are self employed or a sole trader

As a sole trader there is no separation between you and the business for tax purposes. All profits are treated as your income regardless of how much cash you physically withdraw.

This is one of the most misunderstood points.

You might only take a small amount out of the business but if the profit is high you will still pay tax on the full amount.

Your tax position is based on:

• Trading profit

• Less allowable expenses

• Plus any other personal income

You then pay:

• Income tax

• Class 2 National Insurance

• Class 4 National Insurance

If you are asking whether you are paying yourself tax efficiently as a sole trader the key questions are:

• Are all allowable expenses being claimed correctly

• Are capital allowances being used properly

• Are pension contributions being considered

• Is your profit level appropriate for remaining self employed

A common issue I see is sole traders overpaying tax because they are overly cautious with expenses or do not realise what is allowable.

Another issue is people staying self employed long after it stops being tax efficient to do so.

Signs a sole trader may not be tax efficient

There are some clear warning signs that tell me a sole trader may be paying more tax than necessary.

These include:

• Profits consistently above higher rate thresholds

• Large cash balances with no planning

• No pension contributions despite high tax bills

• No review of whether incorporation makes sense

At a certain point the question is not how you pay yourself but whether the structure itself is still right.

If you are a limited company director

This is where tax efficiency becomes more flexible but also more complex.

As a director shareholder you have several ways to pay yourself including:

• Salary

• Dividends

• Pension contributions

• Benefits in kind

Each of these is taxed differently and the mix matters far more than any single method.

In my experience the biggest mistake directors make is either taking everything as salary or taking money randomly without a plan.

Understanding salary and dividends properly

A salary is subject to:

• Income tax

• Employee National Insurance

• Employer National Insurance

Dividends are taxed differently:

• No National Insurance

• Dividend allowance applies

• Different tax rates depending on your band

A common and often sensible approach is a small salary combined with dividends. However the exact level depends on:

• Personal allowance availability

• Other income

• Company profits

• State pension record

• Future plans

There is no one size fits all figure. Anyone giving you a fixed number without context is guessing.

How I assess whether a director is paying themselves efficiently

When I review a director’s position I look at the full picture not just the tax rate.

Key areas I review include:

• Salary level relative to thresholds

• Dividend amounts and timing

• Whether dividends are legal and affordable

• Use of the personal allowance

• Use of the dividend allowance

• Overall effective tax rate

I also look at whether money is being left in the company unnecessarily or withdrawn too aggressively.

Paying too little can be just as problematic as paying too much.

The role of pensions in tax efficient pay

Pensions are one of the most underused tools in tax planning especially for directors.

Employer pension contributions are:

• Deductible for corporation tax

• Not subject to income tax or National Insurance

• Not limited by salary level in the same way as personal contributions

This means that for some business owners the most tax efficient way to extract profits is not through salary or dividends at all.

Instead profits are redirected into long term savings while reducing the tax bill.

If you are paying higher rate tax and not using pensions at all it is almost always worth reviewing.

Understanding timing and why it matters

Tax efficiency is not just about how much you take but when you take it.

I regularly see situations where:

• Dividends are taken in the wrong tax year

• Income pushes someone into a higher band unnecessarily

• Payments on account are inflated

• Child benefit is clawed back unexpectedly

Small timing changes can have a big impact.

For example deferring income by a few weeks or splitting dividends across tax years can reduce tax without changing the total amount withdrawn.

This is where planning matters far more than calculation.

How other income affects your efficiency

Many business owners focus only on their business income and forget everything else.

Your tax efficiency is affected by:

• Employment income

• Rental income

• Savings interest

• Capital gains

• Partner’s income in some cases

I have seen directors accidentally lose their personal allowance or trigger high income child benefit charges simply because business income was not considered alongside other sources.

Efficiency only exists when everything is viewed together.

Common signs you may not be paying yourself efficiently

There are several red flags I notice when someone asks this question.

These include:

• You do not know your marginal tax rate

• You take money out when needed without planning

• You are surprised by your tax bill each year

• You do not know how much tax you paid last year

• You have never reviewed your structure

If tax feels unpredictable that is usually a sign that efficiency is lacking.

Why copying what others do is risky

One of the most common things I hear is someone saying that a friend pays less tax or does things differently.

This is rarely a helpful comparison.

Tax efficiency depends on:

• Income level

• Family situation

• Business stability

• Long term goals

• Risk tolerance

What works for one person may be completely wrong for another.

I have seen people copy dividend strategies that later caused serious problems because profits were not there or reserves were needed.

How an accountant actually adds value here

Calculating tax is the easy part. Planning is where value sits.

A good accountant will:

• Model different scenarios

• Explain trade offs clearly

• Keep you within the rules

• Adjust plans as income changes

• Spot issues before they become expensive

This is not a once a year conversation. The most tax efficient clients are the ones who review things regularly.

Understanding effective tax rate not just headline rates

Many people focus on the tax rate applied to a specific type of income. That is only part of the story.

What really matters is your effective tax rate which looks at:

• Total tax paid

• Divided by total income

Two people can both pay tax at higher rates but have very different effective outcomes depending on allowances pensions and structure.

If you have never looked at your effective tax rate you are missing the bigger picture.

Balancing tax efficiency with lifestyle and cash flow

It is important to say this clearly. The most tax efficient option is not always the right one.

Locking money away in pensions might reduce tax but harm cash flow. Leaving money in a company might defer tax but limit personal flexibility.

Tax efficiency must support your life not restrict it.

This is why context matters and why rigid rules rarely work.

Planning for changes before they happen

Tax efficiency is not static. It changes as your income grows your family situation evolves and rules shift.

Key life events that should trigger a review include:

• Income increases

• Starting or stopping child benefit

• Buying property

• Taking on staff

• Approaching retirement

I often say that tax planning done too late is not planning at all.

How to sense check your current position yourself

If you want a simple way to reflect on whether you are paying yourself efficiently ask yourself:

• Do I understand how my income is taxed

• Do I know my thresholds and allowances

• Am I surprised by tax bills

• Have I reviewed this in the last year

• Could I explain my strategy clearly

If the answer to most of these is no then efficiency is probably not optimal.

Final thoughts

Paying yourself tax efficiently is not about tricks or secrecy. It is about understanding your options and making deliberate choices.

In my experience the biggest waste of tax comes from inaction not complexity. People stick with what they have always done even when their situation has changed.

Whether you are self employed or running a limited company the key is clarity. When you understand how money flows and how it is taxed you regain control.

If you are unsure whether you are doing things efficiently that uncertainty itself is a signal. A proper review can often improve outcomes without increasing risk or stress.

Tax efficiency is not about beating the system. It is about using it properly so your hard work benefits you and your future not just the tax bill.

You may also find our guidance on How do I pay myself from my small business and How can I plan for my pension as a small business owner useful when exploring related small business questions. For a broader range of practical advice, you can visit our small business guidance hub.