Are you still taking the right mix of salary and dividends?

Now that a new tax year has begun it is a good time to review the perennial question for company directors of how much income to take as salary and how much as dividends.

Rates for the latter rose from April so what was the most tax-efficient approach for some companies may no longer be, particularly in terms of what the optimal amount of salary to take is.

And directors who are beginning to need a bigger mortgage may want to bump up their salary relative to dividend income to increase their borrowing power.

In addition directors who are starting to have their retirement in sight ought to check they are up to date with state pension contributions – something that can be a problem for those who pay themselves in dividends. They may also want to make more use of the tax advantages of funnelling earnings into a pension scheme as opposed to taking it as income.

So whether it is due to an anticipated change in life or in response to new thresholds or the new tax year, directors should be reviewing how they are paid.

What works for the typical director

Company directors pay themselves in salary, dividends (a share of profits) and pension contributions. Exceptionally they may also make themselves a director’s loan, which is a payment in excess of what they put into the company.

Typically a director will take salary up to the level of the relevant tax threshold and receive the rest of their income in dividends and pension contributions.

Dividends make up the bulk of most directors’ income as they are taxed at a lower rate than earnings and no national insurance is payable on them.

Currently the most tax-efficient director’s salary is one of £5,000, £6,708 or £12,570 – these numbers align with national insurance or income tax thresholds.

How the mix has shifted

In April dividend tax rates rose to 10.75% and 35.75% for basic rate and higher rate taxpayers. The rate for additional rate taxpayers remained at 39.35%.

The tax-free dividend allowance was kept at £500 and the personal savings allowance stayed at £1,000 for non-ISA interest income. Higher rate taxpayers receive only a £500 allowance and additional rate taxpayers do not get one at all.

The tax-free personal allowance remains at £12,570 a year and is due to stay at that level until at least 2031. Higher rate and additional rate thresholds are also not expected to change.

Dividends taken within ISAs and Lifetime ISAs remain tax free. Tax on savings will increase by two percentage points in April 2027.

From April 2027 the limit on adding cash to an ISA will fall to £12,000 a year for those aged 64 and under so this tax year is the last opportunity to maximise deposits in a cash ISA.

The employer’s national insurance rate of 15% will be paid by your company on your earnings as a director. The 15% rate replaced the old rate of 13.8% in April 2025. At the same time the threshold at which employers start paying national insurance contributions (NICs) was cut to £5,000 while the employment allowance increased to £10,500.

Using thresholds efficiently

Keeping director’s salary below £5,000 a year means there is no liability for employer’s Class 1 NICs. Another advantage of staying below this threshold is you will not have to register as an employer or operate PAYE unless any of the following applies to another director or employee in the company:

• Earns £129 or more a week.

• Receives expenses and company benefits.

• Gets a pension.

• Has another job.

• Receives some state benefits.

However, it should be noted that directors who pay themselves beneath the £5,000 threshold will not earn qualifying NICs.

The £6,708 threshold (the secondary threshold) mentioned above relates to the NIC lower earnings limit. Directors (or employees) should be paid at least this amount to retain entitlement to the state pension and other benefits, as even though NICs have not been paid HMRC treats the earnings as if they have been, so essentially they amount to free pension contributions.

It makes sense in companies that are eligible for employment allowance for directors to pay themselves at above the NIC primary threshold, which is £12,570, the same as the personal allowance. Above this threshold both the company and the director will pay NICs, however, the employment allowance means companies can reduce their annual NI bill by up to £10,500 a year.

Another consideration is that directors’ salaries are deductible against the corporation tax bill, another reason why it can be tax efficient to take some income as salary.

Overall, a sole director company is likely to find it most tax-efficient for the director to be paid £12,570 in salary rather than at or above the secondary threshold of £6,708. This is because the company does not have to pay corporation tax on the difference between the two figures or on the NICs between the two figures. While there is an employee’s NI rate of 8% this is less than the corporation tax rate of 19%.

Dividends

Dividends are paid out of profits so are net of corporation tax liability. The personal allowance can be used against dividend income so a director whose only income is dividends will have an allowance of £13,070 a year (the personal allowance plus the £500 dividend allowance). The director must be a shareholder to be able to take dividends.

Another advantage of dividends is that unlike a salary from which tax is deducted each month, tax on dividends is paid via self assessment. Thus a dividend tax liability from the 2026-27 tax year will not have to be paid until January 2028 (although payments on account are likely to be required).

Dividends can be paid when appropriate to the company’s performance thus providing useful flexibility relative to a salary, which must be paid in full each month. This is particularly useful in companies that have fluctuating cashflow.

However, if a company’s profits are small, directors may be forced to take more income as salary. Dividends can only be paid out of profits net of tax; taking dividends in excess of available profit will lead to HMRC penalties and charges, and money taken out of the company will have to be paid back in. Furthermore, dividends must be properly declared and reported. If they are not, HMRC may reclassify them as salary, which will trigger additional NIC and PAYE liabilities.

Company v self-employed

Taking dividends is not an option for the self-employed person. Self- employment income is taxed at income tax thresholds and rates of 20%, 40% and 45%. Unless the trader’s income is less than the personal allowance it is more tax efficient to trade as a company as corporation tax on smaller companies is at a rate of 19%, although there is no allowance with corporation tax.

But the running costs of a company are likely to be higher and there are legal requirements about company records, accounting and reporting, adding up to a higher administrative burden compared with a self-employed business.

Risks of sticking with old advice

What worked before may no longer be efficient, as the gap between salary income and dividend income is narrowing. Furthermore, dividend income may fluctuate making financial planning more difficult.

Directors who mainly live on their dividends ought to review the benefits of taking more income as salary. They include:

• Building up qualifying years for the state pension (35 years are required for the full pension).

• Being able to make higher personal pension payments.

• The ability to take out a larger mortgage or loan.

• Reducing corporation tax liability.

Common mistakes

The lower tax rates of dividends relative to income tax rates mean most directors take the majority of their income as dividends. However, if relevant thresholds are ignored this can be inefficient. A director on say £120,000 a year ought to be using the full income tax basic rate 20% allowance to cut the amount of dividends charged at 35.75% to the minimum.

Sometimes directors overlook the advantages of salary. Some state benefits, such as pensions and maternity benefits, are linked to NICs so those directors who are not paying NICs because they are living on dividends may be behind on their payments.

Furthermore, lenders are less likely to include dividend income in assessing eligibility for loans, which can be a problem for people who want to take out a mortgage or car loan as they find they cannot borrow against their full income.

The need for an annual review

The two percentage point increase in tax rates for income from dividends and property due to come into force in April 2027 indicates that the government is responding to pressure to narrow the gap between tax rates on PAYE and other income, and it would not be at all surprising if it continued to do so, given the weak state of the public finances.

Allowances may change as well (with the unfortunate exception of the personal allowance, which is stuck at £12,570 for the foreseeable future) making an annual review an important way of ensuring maximum tax efficiency.

An annual review also makes sure remuneration is in a form that reflects longer-term goals relating in particular to home ownership and retirement.

Conclusion

Directors face a difficult landscape of higher employment costs, frozen allowances, increased dividend taxes and in many sectors a challenging trading environment. All the more important then to make sure that tax planning is rock solid and as much income as possible is retained.

Expert, tailored advice can make a big difference to the tax bill paid by a company or individual. To make sure you are getting the best out of the available allowances and are paying no more tax than you need, please contact Finsbury Robinson.

We offer a full suite of tax, accounting and business advisory services, and our friendly and highly experienced team is available on 020 8858 4303 or via email at info@finsburyrobinson.co.uk