Directors' Salary vs Dividends: Optimising Your Tax Efficiency
As a company director, one of the most important decisions you’ll make is how to extract money from your business. The balance between taking a salary and receiving dividends can significantly impact your overall tax liability, making this a crucial area for tax planning.
The Current Tax Landscape
For the 2025/26 tax year, directors face different tax treatments for salary and dividends. Salaries are subject to income tax, National Insurance contributions (both employee and employer), and PAYE, while dividends attract dividend tax but are exempt from National Insurance.
The dividend tax rates are 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers, and 39.35% for additional rate taxpayers. However, dividends can only be paid from company profits after corporation tax has been deducted.
The Optimal Strategy
Most tax-efficient extraction typically involves taking a small salary combined with dividends. The sweet spot is often paying yourself a salary equal to the National Insurance Lower Earnings Limit (£12,570 for 2025/26), which preserves your National Insurance record without triggering employee National Insurance contributions.
This approach allows you to utilise your personal allowance while avoiding unnecessary National Insurance. The remainder of your income can then be extracted as dividends, taking advantage of the dividend allowance and lower effective tax rates.
Factors to Consider
Your optimal salary-dividend split depends on several factors. Total income level affects which tax bands apply, while pension contribution plans may favour higher salaries to maximise annual allowances. Directors with other employment income need to consider their cumulative tax position.
The Employment Allowance of £10,500 for 2025/26 can significantly impact the calculation for companies with multiple employees or directors. This allowance reduces the employer’s National Insurance liability, potentially making higher salaries more attractive from a company perspective, though it’s not available to companies where the director is the sole employee.
State pension considerations also play a crucial role. To qualify for a full state pension, you need 35 qualifying years of National Insurance contributions. Directors approaching retirement may need to ensure their salary meets the Lower Earnings Limit (£12,570 for 2025/26) to secure qualifying years, even if this isn’t the most tax-efficient approach in the short term.
Additionally, mortgage applications often favour salary income over dividends, so if you’re planning to apply for a mortgage, a higher salary might be beneficial despite the tax implications.
Professional Advice is Essential
Tax legislation changes regularly, and individual circumstances vary significantly. What works for one director may not suit another. The calculations involved in optimising your remuneration strategy can be complex, particularly when considering corporation tax, personal tax, and National Insurance interactions.
We recommend reviewing your salary-dividend strategy annually and seeking professional advice to ensure you’re maximising tax efficiency while meeting your personal financial goals.
This article provides general guidance only and should not be considered specific tax advice. Please consult with a qualified accountant to discuss your individual circumstances and ensure compliance with current tax legislation.
