How Do I Pay Myself in Year One Salary or Dividends

One of the biggest questions new company directors face in the first year is how to pay themselves. When someone forms a limited company the money inside the company is not automatically their personal money. This creates confusion particularly for first time founders who are used to being employed and receiving a regular salary. Understanding how salary and dividends work in the UK helps you choose a method that supports cash flow, avoids tax problems, and keeps the business safe during its early months.

This guide breaks down how directors can pay themselves legally and efficiently in year one, how each option works, and the points that matter most when the company is still new.

Why Year One Is Different From Later Years

The first year of trading is often unpredictable. Revenue is variable, costs can be high, and the business may take time to generate consistent profit. This means paying yourself requires careful thought.

In year one directors must consider:

• Cash flow stability

• Whether the company is profitable

• How much the company can afford

• Tax implications of each payment method

• The risk of creating director’s loan issues

• Long-term plans for growth

Because companies pay Corporation Tax on profit then directors pay personal tax on salary or dividends taken from the company the strategy chosen can make a big difference to total tax paid.

Understanding the Two Main Options: Salary and Dividends

Directors can legally take money from their company in two main ways:

1. Salary

A salary is paid through PAYE and counts as an allowable business expense. This reduces the company’s Corporation Tax. Salaries can be paid monthly, weekly, or as needed. They must follow payroll rules and require RTI submissions to HMRC.

2. Dividends

Dividends are paid from profit after Corporation Tax. They are not a business expense. They must be supported by retained profit which means the company cannot pay dividends if it has not made enough profit to cover them.

Both options are legitimate. The right choice depends on cash flow, tax planning, and personal income needs.

How Salary Works for Directors in Year One

A salary is treated in the same way as employment income. It has tax, National Insurance, and reporting requirements. Many directors choose to pay themselves a small salary below certain thresholds to stay tax efficient.

Key features of a salary:

• It is processed through PAYE.

• The company must register as an employer.

• It counts towards qualifying years for the State Pension.

• It reduces Corporation Tax because it is an allowable expense.

• It may create National Insurance contributions if earnings exceed thresholds.

Salary thresholds worth knowing:

There are three important thresholds for directors:

1. Lower Earnings Limit
   If salary is above this level the director earns a qualifying year for State Pension entitlement.

2. Primary Threshold
   Above this level the director must pay employee National Insurance.

3. Secondary Threshold
   Above this level the company must pay employer National Insurance.

Many directors choose a salary positioned between the Lower Earnings Limit and the Primary Threshold. This keeps personal tax and employee National Insurance at zero but still gives a qualifying pension year.

Why some directors choose salary in year one

• Protects State Pension entitlement.

• Reduces Corporation Tax.

• Creates a regular income that mirrors employment.

• Helps when applying for mortgages because lenders like payslips.

However a salary increases company administration which may feel heavy in the early months.

How Dividends Work for Directors in Year One

Dividends are payments to shareholders from company profit. They do not involve PAYE and are declared through Self Assessment. They must follow strict rules.

Key features of dividends:

• They must be paid only from distributable profit.

• They require board minutes and dividend vouchers.

• They cannot be paid if the company is loss making.

• They do not reduce Corporation Tax.

• They are taxed differently from salary.

Dividends are popular because they often result in lower National Insurance costs. However they can only be paid if the company has genuinely made profit. In year one many businesses do not make profit immediately which limits dividend use.

Dividend tax considerations:

Dividend income:

• Has a tax free dividend allowance

• Is taxed at different rates depending on personal income

• Must be included in your tax return

In year one dividend income can be helpful for tax planning but risky if profits fluctuate.

Why Many Directors Use a Combination of Both

The most common structure for UK directors is a low salary with the remainder taken as dividends. This approach balances three things:

• Tax efficiency

• Cash flow

• Long-term pension planning

For example a director might take a salary at the optimal tax threshold then top up with dividends once profit builds. This is often suitable from year two onwards but year one can require more caution because profits may not yet exist.

What Happens If You Pay Yourself Without Using Salary or Dividends

One of the biggest risks new directors face in year one is withdrawing money from the business without classifying it correctly. When money is taken without salary or dividends it usually becomes a director’s loan.

What is a director’s loan?

A director’s loan is money taken from the company that is not:

• Salary

• Dividend

• Expense reimbursement

• Repayment of personal funds you put into the business

If taken incorrectly it creates problems such as:

• An overdrawn director’s loan account

• Potential Corporation Tax charges

• Possible penalties if not handled correctly

In year one this is extremely common because new directors do not realise the money in the company account is not automatically theirs.

A specialist accountant helps avoid this issue by establishing the correct payment structure from day one.

How Profit Affects the Decision

The company’s profit determines whether dividends are permitted and whether the company can afford a salary.

If the company makes a profit:

• Dividends may be paid legally

• A small salary is allowable and reduces Corporation Tax

• A combined approach often becomes possible

If the company makes a loss:

• Dividends cannot be paid

• Salary remains possible but only if the company has cash to cover it

• A salary will increase company losses which may help future tax relief

Directors sometimes assume they can pay themselves dividends even if the bank account has money from sales. This is incorrect. Dividends are based on accounting profit not cash in the bank.

Cash Flow Considerations in Year One

Cash flow is often more important than profit in the early months. Directors must consider:

• Whether the company can afford a salary

• Whether tax bills from salary or dividends will strain cash flow

• How much working capital is needed to support growth

• Timing of payments on account

• When VAT may become due

Salaries tend to be predictable but increase payroll costs. Dividends are flexible but rely on profit.

In my opinion cash flow stability often matters more than tax planning in year one. Many directors take minimal income until the business stabilises.

Real UK Examples

Example 1: The New Consultant With One Client

A consultant leaving employment starts a limited company. The first few months are quiet. They take a very small salary to maintain pension entitlement but delay dividends until a contract begins. This avoids breaking dividend rules when the company has little profit.

Example 2: The E-commerce Start Up

An online retailer invests heavily in stock and marketing in year one. Although sales rise the company does not technically make profit because costs are high. Because dividends are not allowed they take a small salary only. Cash flow is protected and no director’s loan issues appear.

Example 3: The Part-Time Director

Someone starts a company while still employed elsewhere. Their PAYE job covers their personal income needs. They leave all company profit in the business in year one then take a combination of salary and dividends in year two when profit is clear.

Example 4: The Growth-Focused Founder

A founder reinvests all revenue. They deliberately do not take a salary or dividends because they want to scale quickly. This is allowed as long as they do not take money informally. Any withdrawals are classified as director loan repayments if they previously funded the business personally.

Tax Differences Between Salary and Dividends

Salary tax:

• Paid through PAYE

• Reduces company profit

• Subject to employee and employer National Insurance

• Counts as allowable business expense

• Creates pension qualifying years

Dividend tax:

• Paid through Self Assessment

• Does not reduce company profit

• No National Insurance

• Pays separate dividend tax rates

• Dependent on profit availability

Many new directors assume dividends are always better. In reality the best choice depends on personal income, company profit, and long-term goals.

Can You Change Your Mind Later?

Yes. A director can adjust the balance between salary and dividends as the company grows. Many people start with a small salary in year one then increase dividends later once profits stabilise. This flexibility makes the combination method popular.

Common Mistakes to Avoid

• Paying dividends when there is no profit

• Withdrawing money as a director’s loan without understanding the tax risk

• Paying too high a salary which forces unnecessary National Insurance

• Forgetting to file PAYE submissions

• Ignoring the impact of payments on account on personal tax

• Confusing turnover with profit

• Missing the need for board minutes and dividend vouchers

Avoiding these saves both money and stress.

How to Choose the Best Method for You in Year One

Here are the key considerations:

Your personal income needs

If you need a steady income a salary may be necessary. If you can delay income dividends may be better later.

Your company’s profit position

If the company is not profitable dividends are not an option. A salary may push the company further into loss which may later help Corporation Tax relief.

Your tax band

Your existing income from employment affects how much tax you pay on dividends. Basic rate taxpayers benefit more from dividends than higher rate taxpayers.

Your long-term plans

If you plan to apply for a mortgage payslips from salary are often more useful than dividend records.

Your appetite for admin

Payroll adds admin. Dividends require compliance. Both must be handled properly.

In my opinion the safest option in year one is a small salary with dividends held back until profit is confirmed.

Final Thoughts

Paying yourself in year one is not always straightforward. Salary and dividends both have value and both require proper planning. The best approach depends on the company’s financial performance, the director’s personal needs, and the long-term vision for the business.

A small salary often forms a stable foundation. Dividends are powerful once profit is predictable. What matters most is avoiding mistakes in year one because these can affect the company for years to come.

Handled correctly paying yourself becomes a structured and stress free part of running a business rather than a guessing game.