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Salary or dividends? For most limited company directors the answer is both, in a particular order: a modest salary up to a National Insurance threshold, then dividends on top, and often pension contributions before either. What changed on 6 April 2026 is that dividend tax rates rose by two percentage points, which shifts the balance and makes the pension route more attractive than it was. This guide explains how each option is taxed in 2026/27 and how directors usually combine them.
Key takeaways
- A salary is a deductible business expense. Dividends are paid from post-tax profit.
- Dividend tax rates rose on 6 April 2026 to 10.75%, 35.75% and 39.35%.
- The dividend allowance is now just £500.
- Most directors take a salary of £12,570, or around £6,708 where Employment Allowance is not available.
- Employer pension contributions often beat both, because they avoid National Insurance and dividend tax entirely.
How salary and dividends are taxed in 2026/27
The two are taxed in completely different ways, which is why the mix matters.
| Salary | Dividends | |
|---|---|---|
| Paid from | Company profit before corporation tax | Profit after corporation tax |
| Corporation tax relief | Yes, deductible expense | No |
| Income tax | 20%, 40%, 45% bands | 10.75%, 35.75%, 39.35% |
| National Insurance | Employee 8% and employer 15% | None |
| Tax-free allowance | £12,570 personal allowance | £500 dividend allowance |
Dividends carry lower headline rates and no National Insurance, which is why they have long been the preferred route. But they come out of profit that has already paid corporation tax, so the comparison is never as simple as comparing the two rates side by side.
The usual approach: a small salary, then dividends
Most directors take a salary set at or near a National Insurance threshold, then take further income as dividends. The salary does three things: it keeps a qualifying year for your State Pension record, it is deductible against corporation tax, and it uses your personal allowance.
Where your company can claim the Employment Allowance, usually where there are two or more employees or directors on the payroll, a salary of £12,570 is generally the efficient choice, because the employer National Insurance is covered by the allowance.
Where you are a sole director with no other employees, Employment Allowance is not available, and employer National Insurance of 15% applies above £5,000. In that case a lower salary of around £6,708 is often more efficient, because it still protects your State Pension record without triggering much employer National Insurance.
Your accountant will run the exact numbers for your company, because the right figure depends on your payroll, your profits and whether the allowance applies.
What changed in April 2026, and why it matters
On 6 April 2026, dividend tax rates rose by two percentage points at the basic and higher rates, from 8.75% to 10.75% and from 33.75% to 35.75%. The additional rate remains 39.35%. The dividend allowance stays at £500.
On its own that is a modest increase, but it continues a clear direction of travel. The dividend allowance was £5,000 in 2017 and is now £500, and rates have risen twice in recent years. For a director taking a substantial dividend income, the cumulative effect is significant, and it strengthens the case for looking at the third option most people underuse.
The third option: employer pension contributions
This is the route most directors overlook, and in many cases it is the most efficient of the three.
An employer pension contribution is normally an allowable business expense, so it reduces your corporation tax bill. It attracts no employee or employer National Insurance. And it is not dividend income, so the new 10.75% and 35.75% rates do not touch it. Money moves from the company into your name, and the only tax event is when you eventually draw it in retirement, at which point 25% is usually available tax free.
The trade-off is access. Pension money is locked away until at least age 55, rising to 57 in 2028, so it suits profit you do not need to live on now. For many owner-managed businesses the sensible split is a modest salary, dividends to cover your living costs, and employer pension contributions for surplus profit you would otherwise leave in the company or take at 35.75%.
Annual allowance rules apply, and unused allowance from up to three previous years can sometimes be carried forward, which is useful after a strong trading year. We cover this in our financial planning for business owners service.
Other things worth knowing
- Dividends need distributable profit. You can only pay a dividend from retained profit after corporation tax. Paying one without it creates an illegal dividend, which HMRC can reclassify.
- Paperwork matters. Dividends need a board minute and a dividend voucher for each payment. It is quick, but it needs doing.
- Director’s loans are not a shortcut. Drawing money as a loan and leaving it outstanding past nine months after your year end triggers a temporary corporation tax charge.
- Mortgages look at salary. Lenders often assess affordability on salary and dividends together, but a very low salary can complicate an application, so factor that in if you are borrowing soon.
Salary or dividends FAQs
Is it better to take salary or dividends?
For most limited company directors, a combination works best: a modest salary up to a National Insurance threshold, then dividends on top. Dividends carry no National Insurance and lower headline rates, but they come from profit that has already paid corporation tax.
What are the dividend tax rates for 2026/27?
From 6 April 2026 the rates are 10.75% at the basic rate, 35.75% at the higher rate and 39.35% at the additional rate. The dividend allowance is 500 pounds.
What is the most tax-efficient director salary in 2026/27?
Where Employment Allowance is available, usually with two or more people on the payroll, 12,570 pounds is generally efficient. For a sole director without Employment Allowance, around 6,708 pounds is often better because employer National Insurance of 15% applies above 5,000 pounds.
Are pension contributions better than dividends?
Often, for profit you do not need immediately. Employer pension contributions are usually an allowable business expense, carry no National Insurance and are not subject to dividend tax. The trade-off is that the money is locked away until at least age 55, rising to 57 in 2028.
Can I pay a dividend if the company has no profit?
No. Dividends can only be paid from retained profit after corporation tax. Paying one without sufficient distributable profit creates an illegal dividend, which HMRC can reclassify as salary or a loan.
Get the mix right for your business
First Equitable is an independent firm of financial advisers with offices in Liverpool and Chester, and our team includes Chartered expertise. We work alongside your accountant to make sure the way you take money out of your company also builds your personal wealth, rather than leaving everything locked in the business. See our business owner planning in Liverpool or in Chester. The first consultation is free, with no obligation and no minimum contract.
Information correct as at July 2026 and based on the rules for the 2026/27 tax year. Tax rules, allowances and thresholds can change, and the value of any tax relief depends on your individual circumstances. The Financial Conduct Authority does not regulate some forms of estate planning, trusts or tax advice. The value of investments can fall as well as rise and you may get back less than you invested. This article is general information only and does not constitute personal advice. You should seek advice specific to your circumstances before acting.
