How Much Should You Pay Yourself?

As a business owner, you have complete authority over your finances. You can decide how much to invest in daily operations, how much to spend on marketing and even how much to pay yourself.

But as they say: with great power comes great responsibility.

With no one guiding you, finding the fine line between rewarding yourself and investing in your business can be difficult. You want to balance the business’ growth but also give yourself the financial strength to make better decisions.

If you’ve ever struggled with figuring out when, how and how much to pay yourself, this post will help you out.

Mr Krabs
via Giphy

Ways to Pay Yourself

While a monthly salary is obviously a widely accepted and easily understood way to pay yourself, there are a number of alternatives as well, each with their pros and cons.

Monthly salary

If your business is registered as a corporation (C-corp or S-corp in the US), you can pay yourself a monthly salary. You get a fixed income each month from the corporation’s profits. The exact amount is decided by shareholders.

In some corporate structures (such as an S-corp in the USA) you are legally bound to pay yourself a salary, howsoever small it may be.

Pros:

  • Monthly salaries are predictable, stable and make for easier accounting.
  • Getting a salary means that you can invest in retirement plans such as a 401k or Canadian RRSP.

Cons:

  • Salaries are 100% taxable, so this might increase your tax burden depending on your country and tax bracket.
  • In some countries, you are liable to create a payroll account with the tax authority to pay yourself.

Learn more: Registering Your E-commerce Business: LLC or Corporation?

Dividends

Apart from salaries, a popular way to pay yourself as a corporation is through dividends. A dividend is essentially any profit extracted from an incorporated business after all its liabilities (including tax) have been taken care of.

Dividends can be extracted as many times and in as large an amount as necessary — provided it is approved by all shareholders.

A lot of business owners prefer to pay themselves small salaries then make up for it by regularly extracting dividends from the company.

Pros:

  • Dividends are usually taxed at a lower rate than wages, so you’ll save on taxes.
  • If you pay yourself in dividends, you might not be liable to pay for mandatory government pension schemes.
  • It is usually easier to pay yourself in dividends — you can write yourself a check and make a record via a director’s resolution.

Cons:

  • Dividends don’t count as “personal income”. This might disbar you from investing in saving instruments like the 401k or Canadian RRSP.

Also read: 8 Great Blogs for Improving Your Financial Literacy

Owner’s draw

If your business is registered as a proprietorship or a sole-member LLC, you can “draw” profits. This is called the “owner’s draw”.

Since the proprietorship is considered to be wholly owned by you, you can draw as much and as frequently as you want. Drawing money from the business reduces your “capital account” (among you’ve invested in the business).

Pros:

  • It’s very easy to pay yourself — you just have to write a check and deposit it into your personal account.
  • No social security/Medicaid or federal/state taxes are withheld on draws, though this might vary from country to country.

Cons:

  • If you pay yourself entirely via draws, you don’t have any personal income on paper. This can cause a problem when applying for mortgages or personal loans.
  • Any draw you take out is taxed as personal income. This can be higher than corporate taxes in some countries.

Most business owners prefer to pay themselves via a mix of salary + dividends/draws. A regular salary ensures that you have a consistent source of income. Any additional profits you want to extract can be done via dividends or draws.

Also keep in mind your country’s taxation structure. In Canada, for instance, if the business makes more than $500,000 in profits, it doesn’t meet the “Small Business Limit” and gets bumped to a higher…