Salary vs Dividends for Company Directors: How Should You Pay Yourself?

Salary vs Dividends Explained

It is one of the first questions we hear from people who have just set up – or are thinking about setting up – a limited company. And it is a good one to be asking. You have probably spent years being paid a salary by an employer. Now you run your own company and suddenly people are talking about salary and dividends and asking which is right for you.

Increasingly, it is also the question that we are asked by people who have been running a business for years. Whether their accountant has never had raised the topic or they’ve been getting advice from Dave-down-the-pub.

The honest answer is: it depends and it is more complex than it used to be. Let’s talk about what those two things are, why a combination of both has historically been a common approach, and what has changed recently that makes it more important than ever to take proper advice.

Firstly, What Is the Difference?

A salary is paid to you as an employee of your company. Even if you are the sole director and only shareholder, your company is a separate legal entity, and when it pays you a salary it is acting as your employer. Always try to think of yourself wearing different legal hats. The salary goes through payroll, is subject to Income Tax and National Insurance (both yours as an employee and the company’s as employer), and is a tax-deductible expense for the company.

Dividends are different. They are not a wage – they are a distribution of the company’s profit to its shareholders. The company can only pay dividends if it has cumulative profits available to distribute (more on why that matters in a moment). Dividends are not subject to National Insurance, and they were historically taxed at lower rates than salary income. Although, as we will come on to, that gap has narrowed significantly. They are paid out of profits after Corporation Tax has already been paid on them.

For many years, the combination of a modest salary topped up with dividends was the standard approach for owner-managed companies. The idea was to pay a small salary to keep your National Insurance record intact protecting your right to a state pension and then take the rest as dividends.

That is no longer a straightforward decision.

What Has Changed in 2026/27

Several things have shifted at once, and together they have fundamentally changed the calculation around salary and dividends to the point where, for many directors, the approach that was once considered standard may no longer produce the outcome it once did.

Dividend tax rates have increased. Basic rate taxpayers now pay income tax at 10.75% on dividends. Higher rate taxpayers pay 35.75% and additional rate taxpayers pay 39.35%. These are meaningfully higher than they were a few years ago, and the gap between dividend tax and income tax rates has narrowed as a result.

The dividend allowance has been cut to just £500. There was a time when you could receive £5,000 of dividends tax-free each year. That allowance has been repeatedly cut and now sits at £500. It mainly exists so that people with a very small amount of income from dividends don’t get pulled into self-assessment.

Employer National Insurance has become more expensive. From April 2025, the employer NI rate increased to 15% and the threshold at which it kicks in dropped sharply to £5,000. For a single-director company without employees, this means employer NI can be payable at a much lower salary level than before and many single-director companies do not qualify for the Employment Allowance that would offset it.

Corporation Tax is no longer a flat rate. If your company’s profits are below £50,000, you pay 19%. Above £250,000, you pay 25%. Between those two levels, you pay an effective marginal rate of around 26.5% which you might have noticed is higher than the headline rate. Where your profits sit in relation to these thresholds directly affects how attractive different extraction methods are.

This means that what worked a few years ago may not work now, and that what is right one year might not be right the next. You need to evaluate your tax position at least every year, possibly more frequently to see if your extraction strategy is still optimised. You also need to consider that what suits one director-shareholder may be quite different from what suits another. Especially if you are not a family unit, have different external circumstances, or are simply at different stages in life.

Is a Limited Company Even Still Worth It?

That is a separate question from how you extract profits, but it is worth addressing briefly, because the two are connected.

The short answer is: it depends on your profit level, your personal circumstances, and what you plan to do with the money. Here is what the 2026/27 numbers actually look like for a single director-shareholder taking a £12,570 salary and extracting the balance as dividends, compared to a sole trader on the same profit:

Based on 2026/27 tax rates. Director draws £12,570 salary; remaining reserves extracted as dividends. Tax gap excludes additional company running costs (typically c.£2,000 p.a.) and does not reflect the many non-tax reasons for incorporation.

At these profit levels, and before factoring in the additional accountancy costs of running a company (typically around £2,000 per year more), a sole trader would take home more money than a director-shareholder extracting profits in the conventional way. The tax advantage of the limited company structure has not just narrowed – on these numbers, it has reversed.

That does not mean incorporation is wrong. Considerations like limited liability, access to investment, and the ability to retain and grow profits in the company mean that there are strong non-tax reasons to incorporate. Sometimes you have no choice because of industry norms which is particularly frustrating. But the tax position is no longer as straightforward as it once appeared, and that is worth factoring into your thinking.

We’ve covered this in more detail in our blog on  Sole Trader or Limited Company: What’s Right for Your Business?

What Is the Right Salary Level for a Director?

There is no single right answer – the correct salary level depends on your specific circumstances. Multiple factors interact to determine what works best for you; some of the most common ones are:

• Whether the Employment Allowance is available to your company, and how much of it remains after other employees’ NI has been run.
  
  
• Whether you are a director only (an officer) or also an employee subject to National Minimum Wage requirements.
  
  
• Your company’s rate of Corporation Tax – the salary is deductible, so the rate on marginal profits affects how attractive a higher salary is.
  
  
• Whether you have other income sources that have already used up your personal allowance.
  
  
• Whether there are other director-shareholders whose positions need to be considered alongside yours.

What we can say is that most director salary decisions involve weighing the NIC cost against the Corporation Tax saving, and that the right number will sit somewhere that reflects your company’s specific position. This is one of the key things we establish as part of a limited company compensation strategy review – and it is worth revisiting several times a year as the rules and your circumstances can change.

Dividends: What You Need to Know

Once the salary is set, dividends are the most common way for a director-shareholder to extract the remaining profits. But there are rules to ensure that the tax treatment is sound.

You can only pay dividends from available profits. A dividend can only be declared if the company has sufficient accumulated retained profits to cover it. Paying a dividend when there are no distributable reserves is unlawful – not just a paperwork problem. Unlawful dividends can be required to be repaid and carry serious tax consequences. Your accountant needs to confirm the position before any dividend is declared.

The formalities must be observed. A dividend needs to be properly declared, documented with board minutes and a dividend certificate, and paid in the right way. This is not bureaucracy for its own sake – it is what makes a dividend a dividend rather than something else with worse tax consequences.

Timing matters. When a dividend is treated as paid affects which tax year it falls into. An interim dividend is taxable when actually paid or credited. A final dividend is taxable when it is declared. Getting the timing wrong – particularly around the 5 April year-end – can shift a payment into the wrong tax year and create an unexpected bill.

Dividend tax rates in 2026/27. The first £500 of dividend income is tax-free. Above that, you pay 10.75% (basic rate), 35.75% (higher rate), or 39.35% (additional rate), depending on where the dividends sit in your overall income. Your company will already have paid corporation tax on these profits at anywhere between 19% and 25%.

We publish Useful Stuff including an easy-to-read infographic on Lawful Dividends on our website: https://composureaccounting.co.uk/know-how/useful-stuff/

Beyond Salary and Dividends

Salary and dividends are the best-known tools, but they are not the only ones and, depending on your circumstances, other elements may also be worth considering as part of a broader extraction strategy.

Pension contributions. Company pension contributions are deductible against Corporation Tax, do not attract National Insurance, and do not form part of your taxable income in the year they are paid. With the annual allowance at £60,000 (and the ability to carry forward unused allowances from up to three previous years), pension contributions can be a highly tax-efficient way to extract value from a company in the right circumstances. The contributions must be wholly and exclusively for the purposes of the trade and must not be considered excessive. Also watch out for the rules on being able to carry forwards unused allowance or you could end up losing it.

Tax-free benefits. Some benefits may potentially be provided by your company without creating a tax liability for you personally. These can include one mobile phone, parking at your workplace, sight tests and glasses needed for screen work, an annual health check, and trivial benefits up to £50 each (capped at £300 per year for directors of close companies). Where the conditions are met, you can benefit from these without adding to your tax bill.

Family arrangements. Where a spouse or family member genuinely works in the business, employing them at a commercially reasonable salary, or involving them as shareholders, can make legitimate use of their personal allowances and tax bands. HMRC scrutinises arrangements to see if they exist primarily to shift income – any salary paid must reflect the genuine work done, and any shareholding must carry real economic substance.

The Thresholds to Know About

Your overall income level – salary, dividends, and anything else – interacts with a number of important thresholds. Being aware of them is essential to planning properly:

• £50,270 – the basic rate limit. Dividends above this level (within your overall income) are taxed at the higher rate. If you make qualifying charitable donations and/or personal pension contributions, your basic rate band may be extended. Get advice from a qualified accountant before doing anything.
  
  
• £60,000 – the High Income Child Benefit Charge starts to apply. If you or your partner receive Child Benefit and your adjusted net income exceeds this, a tax charge reduces and then eliminates the benefit. Pension contributions could be useful in this area but they need to be the right kind at the right time. Don’t take risks and get proper personal advice before doing anything. 
  
  
• £100,000 – your personal allowance starts to be withdrawn, at £1 for every £2 of income above this level. The effective tax rate in this band is significantly higher than the additional rate. Same goes for pension contributions here.
  
  
• £125,140 – your personal allowance is fully withdrawn. All income above £100,000 has effectively been taxed at 60% until you reach this point.

These thresholds are why extraction planning cannot be done in isolation. Your full income picture including any rental income, interest, other employment, or pension in payment needs to be factored in.

What This Means in Practice

If you are a director-shareholder, the most important thing to understand is this: there is no universal formula that works for everyone. The right approach depends on so many interdependent and personal factors.

What worked for someone else or what worked for you last year may not be the right answer now. The tax rules have changed, and they keep changing.

At Composure, we carry out a structured compensation strategy review for our clients at the beginning and before the end of every year. We look at all the variables, model the options, and give you a clear tailored approach – not a generic one-size-fits-all soundbite. If you are not currently a client and would like to understand what the right strategy looks like for your situation, you can access this as a either a retained or a standalone one-off service.

FAQs

We work holistically with our clients – the same team looks after you, your business, and your family. If you would like to talk through your extraction strategy or any aspect of our accountancy services, book a discovery call with the team. We would love to help.

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