If you run your business through a limited company and you’re asking how to pay yourself, the salary vs dividends question is one of the first things you’ll encounter — and one of the most misunderstood. The basic logic is straightforward: salary is subject to Income Tax and National Insurance, dividends are not subject to NI and are taxed at lower rates. So you pay yourself a modest salary and take the rest as dividends. Simple enough.

Except it isn’t quite that simple. The April 2026 changes pushed dividend tax rates up by 2% across the board, the dividend allowance has been cut to just £500, and the optimal salary level for directors has shifted depending on your company’s circumstances. We help a lot of directors get this right, and the difference between an informed split and an uninformed one can run into thousands of pounds a year. Here’s how we think about it.

The logic sits in how each type of income is taxed. When your company pays you a salary, the payment is a deductible business expense — it reduces your company’s taxable profit and therefore its Corporation Tax bill. But you pay Income Tax on the salary through PAYE, and you pay employee National Insurance on anything above £12,570. The company also pays employer’s NI on salary above that threshold.

Dividends are different. They’re paid out of profit that has already been taxed at the company level, so HMRC doesn’t allow a further Corporation Tax deduction. But they carry no National Insurance liability at all, and the tax rates on dividends are materially lower than equivalent Income Tax rates. For 2026/27 the basic rate of dividend tax is 10.75%, compared with 20% Income Tax on the same band of income. The higher rate is 35.75%, against 40% for earnings.

Put those together and the appeal is obvious: a low salary extracts some income tax-free (and builds your NI record), while dividends bring out the rest at lower effective rates. The question is where to set the salary, and that’s where most directors either leave money on the table or unknowingly create a tax cost they didn’t need.

The most common approach is to set director salaries at around the Primary Threshold — currently £12,570 — which aligns with the Personal Allowance. At that level, no Income Tax is due on the salary, and no employee or employer National Insurance is triggered either. The salary still counts as a deductible expense for the company, so you’re getting a Corporation Tax saving without incurring NI on either side.

The remaining profit is then extracted as dividends. The first £500 of dividends each year falls within the dividend allowance and is tax-free. Dividend income within the basic rate band (up to £50,270 of total income) is taxed at 10.75%. So for a director with a £12,570 salary, the next £37,700 of dividends sits in the basic rate band and is taxed at 10.75% rather than the 20% they’d pay if they’d taken it as salary.

That’s a meaningful saving. And because neither the salary nor the dividends in the basic rate zone carry any NI, the overall tax burden on income up to around £50,000 is considerably lower for a director taking salary plus dividends than it would be for a sole trader or employee on equivalent earnings.

Worth noting: dividend income does not count as pensionable earnings, which matters if pension contributions are part of your planning. Salary does. That’s a consideration we return to later.

Not always, and this is where it gets more interesting. The standard £12,570 salary works well for a single director with no other employees. But if your company qualifies for the Employment Allowance — which covers up to £10,500 of employer NI each year — the calculation shifts.

Companies with at least two directors on payroll, or with other employees, can often claim Employment Allowance. A sole director with no other staff cannot. When the Employment Allowance is available, it cancels out employer NI on higher salary levels, which means taking a salary above £12,570 can still be NI-neutral for the company while delivering a larger Corporation Tax deduction on the higher payroll cost.

For a two-director company in 2026/27, the optimal salary can be significantly higher than the basic threshold — the precise figure depends on profit levels, but the principle is that a higher salary reduces the company’s profit subject to Corporation Tax at up to 26.5%, while Employment Allowance absorbs the employer NI that would otherwise apply. The net effect can be a lower overall tax bill.

In Scotland the calculation differs again because of the intermediate Income Tax band, which changes the point at which salary becomes less efficient than dividends. If you’re based north of the border, that’s a conversation worth having separately with an accountant familiar with Scottish rates.

There are situations where the standard low-salary, high-dividend model isn’t the best fit, and it’s worth being honest about them.

Mortgage applications

Lenders typically assess affordability based on salary (and sometimes retained profit), but many still discount dividends or treat them inconsistently. If you’re planning a mortgage application in the next year or two, a higher salary on record can be worth the extra tax cost — though this depends heavily on the lender and how they treat director income. It’s worth speaking to a mortgage broker who works with company directors before you set your salary for the year.

Pension contributions

Employer pension contributions made directly from the company are deductible against Corporation Tax and don’t require the income to pass through payroll first. That’s often more efficient than taking dividends and funding a pension from post-tax income. If pension saving is a priority, it’s worth modelling this separately rather than treating it as an afterthought once the salary/dividend split is decided.

Higher rate taxpayers

Once your total income exceeds £50,270, dividends are taxed at 35.75%. That’s still lower than the 40% higher rate on earnings, but the gap has narrowed since April 2026. At this level, the salary vs dividend decision requires a closer look at the numbers — particularly if retaining profit in the company is an option you’re comfortable with.