Drawings vs. Wages: What’s the Best Approach for Business Owners?
As a business owner, choosing how to pay yourself is a crucial decision. Should you take informal drawings from your business’s profits, or opt for a formal wage processed through PAYE? Each method has its own set of benefits and considerations. In this post, we break down the pros and cons of both approaches to help you make a well-informed decision.
What Are Drawings?
Drawings involve withdrawing funds directly from your business’s profits. This method is common for small business owners, regardless of operating as a sole trader, partnership or company and where personal and business finances are closely linked.
Pros of Drawings:
Simplicity and Flexibility: You can access funds as needed without the complexities of a formal payroll system.
Cash Flow Management: Withdraw funds in line with your business’s performance, providing freedom to manage your finances.
Interest Opportunity: Instead of having your tax money sitting idle with the IRD, you can use it to earn interest or work for you.
Lower Administrative Overhead: No need to set up or maintain a payroll system, reducing both administrative burden and associated costs.
Cons of Drawings:
Provisional Tax Requirements: If your residual tax exceeds $5,000 per year, you’ll fall into the provisional tax regime. This means you must make larger, chunkier tax payments, so discipline in saving is essential.
Manual KiwiSaver Contributions: Unlike wages processed through PAYE, KiwiSaver contributions must be managed manually, requiring extra attention to ensure you’re meeting your retirement savings obligations.
If you choose to take drawings, it’s essential that you become a master at saving for tax. Check out our article on recommendations for what you need to be setting aside.
Wages Through PAYE
What Are Wages Through PAYE?
Paying yourself a wage via PAYE involves setting up a formal payroll system and treats you like any other employee in NZ.
Pros of Wages:
Tax paid as you go: Tax is paid as you go, which will reduce business profits and your end of year tax obligations.
Clear Financial Separation: Separating your personal and business finances can simplify accounting and financial management, and help with setting personal budgets whilst letting your business bank accounts grow.
Cons of Wages:
Potential Overpayment of Tax: Paying too high a wage can lead to overpaying tax for the year, with adjustments required at year-end during tax returns.
Payroll Solution Costs: If your business has more than one employee, the subscription fees for payroll solutions (such as Xero) have become quite expensive, adding to your overall administrative costs.
Finding the Right Balance
Some business owners in New Zealand choose a hybrid approach—drawing a modest regular wage through PAYE to ensure stable income and benefit from streamlined tax administration, while taking additional drawings when profits are strong. This balanced strategy can provide:
Stability: A consistent salary supports everyday expenses and provides a reliable income record.
Flexibility: Additional drawings allow you to capitalize on business success without committing to high fixed payroll costs during leaner periods.
Our recommended approach
In most situations, if a business owner is good with their finances and is prepared to be habitual about saving for tax as they go, we recommend taking drawings and letting your money work for you - the pros outweigh the cons of paying wages. However, if you know you can’t help yourself when you see that big tax savings money sitting there, wages might be a better option.
Conclusion
Deciding between drawings and wages depends on your business structure, cash flow, and personal financial goals.
Drawings offer simplicity and flexibility, along with the opportunity to have your tax money work for you through interest earnings. However, they require discipline in managing tax obligations and KiwiSaver contributions.
Wages provide regular income and clear financial separation, with the benefit of being tax efficient as a business expense, though there is a risk of overpayment if not carefully managed and additional payroll solution costs to consider if you have multiple employees.
If you need help working out what the right option is for you, get your accountant or financial advisor to help provide tailored advice for your unique business needs.