We have developed a number of tools to help answer this question. This guide includes an overview of the methods used.
In the context of the director - when a limited company makes a profit, the amount leftover can be either taken entirely as a dividend or a mixture of salary and dividends.
Dividends can be distributed only after corporation taxes have been paid, however salary can be taken from PRE-tax profit. This means any salary taken will reduce the corporation tax bill the company incurs.
Corporation tax does not have a tax-free allowance, and no bands (at the moment - 2019!). It is charged at 19% of the entire profit declared. So any salary amount taken will reduce the corporation tax bill by 19% of the amount taken.
Another reason for taking a salary is that if the director is paying the majority of their income in dividends, a salary above the lower earnings limit will earn them national insurance qualifying years for their eventual state pension.
The level of the salary taken is a balance between utilising the entirety of the tax-free allowance, or avoiding both tax and national insurance on the salary.
To avoid paying any national insurance AND tax you would take a salary below the primary threshold. This is currently about £4,000 less than the personal allowance. Another factor is that BOTH company and employee are liable to pay national insurance contributions of the salary.
Dividends are taxed after their own £2,000 tax-free band, and then at lower rates than regular income tax starting at just 7.5%. You don't have to declare the entire profit declared as a dividend, opting to retain it in the company for another year.
These scenarios are covered by our dividend vs salary calculator.
The calculator cannot cover more non-quantitative factors for why you may want a higher salary. If there is a contract of employment between your company and you then taking a very low salary for regular working hours may break minimum wage regulations. In addition, a low salary may negatively impact external insurances that are based on salary.