If you run a limited company and take money out of it, how you structure those payments makes a significant difference to how much tax you pay. The combination of a modest director's salary plus dividends is generally more tax-efficient than a pure salary — but "generally" is doing a lot of work in that sentence. The right structure depends on your other income, whether you have a spouse or civil partner, your pension strategy, and your company's profitability. This guide explains how it works in 2025/26.
Why Not Just Take a Salary?
If you pay yourself purely via PAYE salary, you and your company both pay National Insurance. In 2025/26, you (the employee) pay 8% employee's NI on earnings between £12,570 and £50,270, and 2% above. Your company pays 13.8% employer's NI on everything above £9,100. Both the salary and the associated employer's NI are deductible from the company's profits for Corporation Tax purposes — but the NI itself is a real cost that reduces the money in your pocket.
Dividends, by contrast, have no NI. That's the fundamental reason the salary-plus-dividends structure is popular.
How Dividends Work
Dividends are a distribution of a company's after-tax profits to its shareholders. You can only pay dividends from retained profits — you cannot pay a dividend if the company has no distributable reserves. This means the company must first pay Corporation Tax on its profits, and dividends come from what's left.
To pay a dividend, the company must hold a board meeting (even if you're the sole director and shareholder), pass a resolution to declare the dividend, and issue a dividend voucher to each shareholder showing the amount and date. This documentation is important — HMRC can challenge dividends that aren't properly documented as potential disguised salary.
Dividend Tax Rates for 2025/26
| Tax Band | Dividend Tax Rate |
|---|---|
| Up to £500 (dividend allowance) | 0% |
| Basic rate (up to £50,270 total income) | 8.75% |
| Higher rate (£50,271–£125,140) | 33.75% |
| Additional rate (above £125,140) | 39.35% |
Note that the dividend allowance has been cut significantly from its previous £5,000 level — it was £1,000 in 2023/24 and £500 from 2024/25 onwards. This has reduced the attractiveness of the dividend strategy at the margins, but it remains substantially more tax-efficient than salary for most owner-directors.
The Optimal Salary Level
Most directors operating through a limited company take one of two salary approaches:
Option A: Salary at £9,100 (below the Secondary NI Threshold)
Setting your salary at £9,100 (the Secondary (Employer) NI threshold for 2025/26) means the company pays no employer's NI. You as the employee pay no NI either (as this is below the Primary threshold of £12,570). The salary is still tax-deductible for Corporation Tax purposes, saving the company 19–25% Corporation Tax on that amount.
The downside: a salary of £9,100 doesn't use your full personal allowance of £12,570. You'll then take the remaining gap as a dividend and pay 8.75% dividend tax on the portion between £500 and £12,570 — which is slightly less efficient than salary would be if you could avoid NI entirely.
Option B: Salary at £12,570 (using the full personal allowance)
Setting your salary at £12,570 (the personal allowance) means no Income Tax on the salary. However, the salary is above the Secondary NI threshold of £9,100, meaning the company pays 13.8% employer's NI on the difference (£3,470), which is approximately £479 in employer's NI. You also pay no employee's NI as you're still below the Primary threshold.
Whether this is better than Option A depends on whether the Corporation Tax saving from the higher salary deduction outweighs the employer's NI cost. At the 19% Corporation Tax rate, the higher salary saves about £659 in Corporation Tax (£3,470 × 19%) — which exceeds the £479 NI cost, suggesting Option B is marginally better. At the 25% rate, it saves about £868 — even more clearly worth it.
However, if you're eligible for the Employment Allowance (which allows companies to reduce their employer's NI bill by up to £5,000 per year), the NI cost disappears entirely. Note: the Employment Allowance is not available if the only employee is a director who is the sole employee.
Worked Example: £60,000 Total Income in 2025/26
Let's compare a purely salary-based approach versus the optimised salary-plus-dividends approach, assuming a company profit of £75,000 and you want to extract £60,000 personally.
Pure Salary: £60,000
| Item | Amount |
|---|---|
| Gross salary | £60,000 |
| Income Tax (20% on £37,430 + 40% on £9,730) | £11,378 |
| Employee's NI (8% on £37,700 + 2% on £9,730) | £3,213 |
| Employer's NI (13.8% on £50,900) | £7,024 |
| Total tax and NI (personal + employer) | £21,615 |
| Net received | £38,385 |
Optimised: £12,570 Salary + £47,430 Dividends
| Item | Amount |
|---|---|
| Salary: £12,570 (within personal allowance) | No Income Tax, minimal NI |
| Employer's NI on salary (13.8% × £3,470) | £479 |
| Corporation Tax on remaining profit after salary | See below |
| Dividends: £47,430 drawn | |
| Dividend allowance (£500 at 0%) | £0 |
| Dividend tax: 8.75% on £34,700 (within basic rate band) | £3,036 |
| Dividend tax: 33.75% on £12,230 (above £50,270 total) | £4,128 |
| Corporation Tax on company profit: 19% on ~£62,000 | £11,780 |
| Total effective tax burden (approx.) | ~£19,423 |
| Net received | ~£40,577 |
The saving in this example is approximately £2,000–£2,500 per year from the optimised structure. At higher income levels, the gap widens further.
When a Higher Salary Makes Sense
Dividends aren't always the right choice. Consider taking more salary when:
- Pension contributions: pension contributions are calculated as a percentage of "relevant UK earnings," which means salary — not dividends. If you want to make large pension contributions and receive higher-rate tax relief, you need sufficient earned income.
- Mortgage applications: lenders typically assess borrowing capacity based on salary plus dividends, but some lenders weight salary more heavily. If you're planning a mortgage in the next year, discuss this with a mortgage broker.
- Maternity/paternity pay: statutory maternity and paternity pay is based on salary. A very low salary means very low statutory pay.
- State pension: you need National Insurance contributions to build your State Pension entitlement. A salary above the Lower Earnings Limit (£6,396 in 2025/26) generates a NI credit even if no NI is due. Check your NI record on the Government Gateway.
Using a Spouse or Civil Partner's Allowance
If your spouse or civil partner is a shareholder in the company, they can receive dividends using their own personal allowance and basic-rate dividend band — effectively doubling the tax-free income available to your household. This is a legitimate tax planning strategy known as "income splitting." However, HMRC will challenge arrangements where a spouse has no commercial involvement in the business and the primary purpose is tax avoidance (the Arctic Systems case and the settlements legislation are relevant here). Taking proper advice before structuring shareholdings is important.
Getting Your Structure Right
The optimal salary and dividend split for your company depends on multiple variables that change year to year: your other income, the company's profitability, your pension plans, NI record, and any changes in tax rates. Running the numbers annually — ideally before April each year — ensures you're not paying more tax than necessary.
At SMD Accountancy, we review salary and dividend strategy with all our limited company clients as part of our annual planning service. If you'd like us to run the numbers for your specific situation, book a free 20-minute call and let's talk through how to structure your remuneration most efficiently.