Salary vs Dividends – which is best
08/10/2025
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Choosing between salary and dividends in 2025/26 isn’t just about picking the lowest tax bill — it’s about balancing tax efficiency, National Insurance savings, pension eligibility, and a sustainable income strategy for your limited company. The table below gives you an at-a-glance view of how each option is taxed, what allowances apply, and the administrative implications, so you can see the key differences before diving into detailed calculations and strategies.
| Feature | Salary | Dividends |
|---|---|---|
| Tax treatment | Subject to Income Tax via PAYE; NICs apply | Subject to Dividend Tax after Corporation Tax is paid |
| Personal allowance | £12,570 (reduced if total income exceeds £100,000) | £12,570 shared with other income sources |
| Rates (2025/26) | 20% basic, 40% higher, 45% additional rate | 8.75% basic, 33.75% higher, 39.35% additional rate |
| NIC impact | Employee: 8% between £12,570–£50,270; 2% above | No NICs payable |
| Dividend allowance | N/A | £500 tax-free allowance |
| Corporation tax link | Paid before profits available for dividends | Paid on post-corporation tax profits |
| Optimal director salary benchmarks | £5,000, £6,500, or £12,570 depending on NIC strategy | Dividends drawn from retained profits |
| Pension contribution eligibility | Qualifies as relevant earnings | Does not count as relevant earnings for pension tax relief |
| Admin | Requires payroll and RTI submissions to HMRC | Declared via Self Assessment return |
What is salary and how is it taxed? (Updated for 2025/26)
Salary is income you pay yourself through your limited company via PAYE, usually as a fixed annual amount split into regular payments. You do not pay Income Tax on your earnings until you exceed the personal allowance, which is £12,570 for the 2025/26 tax year (unchanged since 2021/22). However, you will have to pay National Insurance Contributions (NICs) if your income passes the Primary Threshold, which is also £12,570 in 2025/26.
To build up qualifying years for the UK State Pension rules, your salary must be at or above the NIC Lower Earnings Limit (LEL) — £6,396 for 2025/26. Many directors set their salary between the LEL and the Primary Threshold to maintain pension eligibility while avoiding NIC payments (if their company does not qualify for the Employment Allowance).
PAYE tax bands 2025/26
The Pay As You Earn (PAYE) system is how HMRC collects Income Tax from your salary before it reaches your bank account. The amount you pay depends on which tax bands your income falls into. These bands have been frozen until April 2028, meaning as your salary rises with inflation, more of it could be taxed at higher rates — a key factor in fiscal drag.
| Tax band | Taxable income | Rate |
|---|---|---|
| Personal Allowance | Up to £12,570 | 0% |
| Basic rate | £12,571 to £50,270 | 20% |
| Higher rate | £50,271 to £125,140 | 40% |
| Additional rate | Over £125,140 | 45% |
For directors, these tax bands matter because salary is taxed before dividends, and the amount of salary taken affects the dividend tax you’ll pay later.
National Insurance (Class 1) 2025/26 — Employee rates
| Earnings range (annual) | Rate | Notes |
|---|---|---|
| £6,396 to £12,570 (Lower Earnings Limit to Primary Threshold) | 0% | No NICs payable, but still counts towards your qualifying years for the State Pension. |
| £12,571 to £50,270 | 8% | Main NIC band for employees — applies to most director salaries above the Primary Threshold. |
| Above £50,270 | 2% | Reduced rate on income above the Upper Earnings Limit. |
Employer NICs: 15% on earnings above the secondary threshold (£9,100 per year), unless the company qualifies for the Employment Allowance (which is worth up to £10,500 in 2025/26). Most single-director companies without other employees do not qualify.
In 2025/26, the LEL is £6,396 (minimum to build pension entitlement), the PT is £12,570 (NICs start at 8%), and the UEL is £50,270 (NICs drop to 2%). The Employment Allowance can offset employer NICs but isn’t available to most one-person companies.
Strategic insight for directors:
If your company doesn’t qualify for the Employment Allowance, setting a salary just above the Lower Earnings Limit (LEL) but below the Primary Threshold (PT) can be the most tax-efficient approach — you’ll build up State Pension entitlement without paying NICs.
If your company does qualify for the allowance, a salary at the full personal allowance (£12,570) can make sense, maximising tax-free income and pensionable earnings while allowing you to claim the NIC savings through the allowance.
Example: £50,270 gross annual salary (2025/26)
Let’s walk through a worked example for a director earning a gross salary of £50,270 in the 2025/26 tax year.
| Step | Calculation | Amount (£) |
|---|---|---|
| Income Tax | Personal allowance | 12,570 |
| Taxable pay = £50,270 – £12,570 | 37,700 | |
| Basic rate tax (20% of £37,700) | 7,540 | |
| Employee NICs | Primary Threshold | 12,570 |
| NIC-able pay = £50,270 – £12,570 | 37,700 | |
| NICs = 8% of £37,700 | 3,016 | |
| Take-home pay | Gross salary | 50,270 |
| Less Income Tax | (7,540) | |
| Less Employee NICs | (3,016) | |
| Net annual take-home | 39,714 | |
| Monthly equivalent | £39,714 ÷ 12 | 3,309.50 |
This works out to £3,309.50 per month before any other deductions such as student loans, pension contributions, or benefits in kind.
Why this matters in 2025/26
With thresholds frozen until April 2028, more directors will be pulled into higher tax bands over time. Regularly reviewing your salary/dividend mix helps maintain tax efficiency, pension eligibility, and cash flow.
Tip: The optimal salary for many directors is either:
- Just above the Lower Earnings Limit (£6,396) if avoiding NICs is a priority and the Employment Allowance isn’t available; or
- At the full Personal Allowance (£12,570) if the company qualifies for the Employment Allowance, to maximise tax-free income and pensionable pay.
Not sure how to split salary and dividends in 2025?
Our expert accountants can help you plan the most tax-efficient mix of salary and dividends—aligned with your income goals, company structure, and HMRC rules.
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What are dividends and how are they taxed?
Dividends are payments made to company shareholders from post-tax profits. For most UK limited company directors, dividends are taken from profits after Corporation Tax has been paid (currently 25% for most companies in 2025/26, with a small profits rate of 19% applying to companies with profits under £50,000).
If your company doesn’t make a profit, you can’t take dividends — even if there’s money in the bank. In those cases, directors may still take a salary, but dividends must come from retained earnings. Dividends can only be paid from retained profits after Corporation Tax has been deducted. If you take more than is available in post-tax profits, it’s classed as a director’s loan and must be repaid. Over-reliance on dividends can also make your income less stable, particularly if profits fluctuate year to year.
Unlike salary, dividends are not subject to National Insurance Contributions (NICs), which is one reason they can be more tax-efficient. However, they do have their own set of tax rates and allowances.
Dividend allowance 2025/26
The tax-free Dividend Allowance has been reduced significantly in recent years — it’s now just £500 for 2025/26 (down from £1,000 in 2023/24 and £2,000 in previous years).
This means the first £500 of dividend income is tax-free, regardless of your other income. Any dividends above that are taxed at the rates shown below, depending on your total taxable income.
Dividend tax rates 2025/26
| Tax band (total taxable income) | Dividend tax rate |
|---|---|
| Basic rate (up to £50,270) | 8.75% |
| Higher rate (£50,271 to £125,140) | 33.75% |
| Additional rate (over £125,140) | 39.35% |
Once your total income passes £50,270, dividend tax increases sharply from 8.75% to 33.75%. While this jump is significant, it’s still often lower than the combined cost of salary tax and NICs
How dividends are taxed alongside salary
Example: Taking a £12,570 salary and £40,000 in dividends means your salary uses up the personal allowance, the first £500 of dividends is tax-free, and the rest is taxed at 8.75% up to £50,270 total income, then 33.75% above that.
Your ability to take dividends also depends on the type of shares you hold. Ordinary shares typically carry equal rights to dividends, while preference shares or alphabet (A/B/C) shares can allow flexibility in paying different amounts to different shareholders.
Why dividends are popular with directors
- No NICs – You avoid employee and employer NICs entirely.
- Lower tax rates – Even at higher income levels, dividend tax rates are generally lower than PAYE rates.
- Flexibility – You can decide when to declare and pay dividends, allowing for tax planning.
Strategic tip: Many directors use a hybrid approach — taking a salary up to the most tax-efficient threshold, then topping up income with dividends to keep overall tax lower while maintaining pension contributions.
Salary vs Dividends – Worked Example (2025/26)
This example compares two common approaches a UK limited company director might take when drawing £50,000 from their business:
- All Salary – taken entirely through PAYE.
- Tax-Efficient Split – a small salary (set around the personal allowance) and the rest as dividends.
Scenario 1 – All salary (£50,000)
Taking all income as salary is simple and predictable, and may be appropriate for those needing consistent PAYE records for mortgage applications or visa purposes. However, the combined effect of Income Tax and NICs (both employee and employer) significantly reduces net take-home. It’s the most costly approach for the company, as employer NICs push the total cost well above the gross salary figure.
| Step | Calculation | Amount (£) |
|---|---|---|
| Gross salary | 50,000 | |
| Income Tax | (£50,000 – £12,570) × 20% | 7,486 |
| Employee NICs | (£50,000 – £12,570) × 8% | 2,997 |
| Employer NICs | (£50,000 – £9,100) × 15% | 6,165 |
| Net take-home pay | £50,000 – £7,486 – £2,997 | 39,517 |
| Total cost to company | £50,000 + £6,165 (employer NICs) | 56,165 |
Scenario 2 – Tax-efficient split (Salary £12,570 + Dividends £37,430)
The hybrid approach keeps salary just high enough to preserve pension eligibility and avoids employee NICs. Dividends, which are taxed at lower rates and not subject to NICs, make up the bulk of income. This structure can save thousands annually compared to an all-salary approach, provided there are enough post-tax profits to declare dividends. It also gives flexibility — dividends can be adjusted year by year depending on profitability and personal tax planning needs.
| Step | Calculation | Amount (£) |
|---|---|---|
| Salary | 12,570 | |
| Dividends | 37,430 | |
| Corporation Tax (25% on £37,430) | £9,357 (paid before dividends) | 9,357 |
| Dividend Allowance | First £500 tax-free | 0 |
| Basic rate dividend tax (8.75%) | (£37,430 – £500) × 8.75% | 3,236 |
| Employee NICs | None – salary at PT threshold | 0 |
| Net take-home pay | £12,570 + (£37,430 – £3,236) = 46,764 | 46,764 |
| Total cost to company | Salary £12,570 + Corporation Tax £9,357 + Dividends £37,430 | 50,000 |
Comparison Summary
For most directors in 2025/26, a small salary combined with dividends offers a better balance of tax efficiency, pension contributions, and cash flow. However, some directors may still opt for a higher salary for practical reasons — for example:
- To maximise mortgage borrowing potential.
- To meet visa or immigration income requirements.
- To contribute more into a salary-linked workplace pension scheme.
Lenders often prefer steady PAYE income when assessing mortgage applications, and large dividend income can sometimes affect your eligibility for certain state benefits.
| All Salary (£) | Salary + Dividends (£) | |
|---|---|---|
| Net take-home | 39,517 | 46,764 |
| Total company cost | 56,165 | 50,000 |
| Difference in take-home | — | +7,247 |
Pros and cons of salary vs dividends in 2025/26
While the worked example shows the numbers, the choice isn’t purely about tax. Your decision should also consider pension planning, mortgage applications, cash flow, and business strategy.
| Aspect | Salary | Dividends |
|---|---|---|
| Pros | Pensionable earnings for State Pension and workplace pensions.
Favoured by lenders for mortgages and loans. Can include employee benefits (if applicable). Deductible business expense, reducing Corporation Tax. |
Lower tax rates compared to PAYE/NICs.- No National Insurance Contributions payable.- Flexible — amount and timing can be adjusted based on cash flow.
Efficient for profitable companies as they are paid from post-Corporation Tax profits. |
| Cons | Higher tax burden due to Income Tax and NICs.
Employer NICs increase the company’s total cost. Less flexible — amounts are fixed unless payroll changes are made. |
Can only be paid from post-tax profits.- Reduced Dividend Allowance (£500 in 2025/26) makes large dividends more taxable
May reduce entitlement to certain state benefits. Do not count as pensionable earnings for State Pension or workplace pensions. |
| Strategic Insight | Hybrid Approach: For most directors, a salary set at either the Lower Earnings Limit (£6,396) or Personal Allowance (£12,570), topped up with dividends, offers the best balance of pension eligibility, NIC savings, and overall tax efficiency. | Hybrid Approach: Same strategy applies — use dividends for flexibility and tax efficiency while keeping a minimal salary for pension and allowance benefits. |
Special considerations in 2025/26
While tax rates and allowances are central to the salary vs dividends decision, other policy changes and economic factors in 2025/26 can have a major impact on your take-home pay.
1. Fiscal drag
- What it is: When tax thresholds are frozen while wages and profits rise with inflation.
- Why it matters: The Personal Allowance (£12,570) and Higher Rate threshold (£50,270) are frozen until at least April 2028, so more directors will be pushed into higher tax bands over time — even without a pay rise.
- Tip: Regularly review your salary/dividend split to offset the impact.
2. IR35 reforms (April 2025)
- Change: HMRC now offsets taxes already paid against any additional liabilities found during an IR35 compliance check.
- Impact: If you’re inside IR35, you’ll be taxed through PAYE, limiting dividend options.
- Action: Review contracts with an IR35 specialist before April 2025.
3. Corporation Tax and marginal relief
- Rates: 19% up to £50,000, 25% over £250,000, with marginal relief between.
- Impact: The amount of post-tax profit affects how much you can take as dividends.
4. Pension planning
- Salary link: Only salaries count towards pension contribution limits.
- Impact: If maximising pension savings, a higher salary may be beneficial despite extra NICs.
5. Cash flow and business planning
- Flexibility factor: Dividends can be delayed until cash flow allows, whereas salaries must be paid as agreed.
- Business growth: Retaining profits in the company can support expansion, investment, or debt repayment — potentially outweighing the benefit of higher personal withdrawals.
Are you planning to set up a limited company?
Deciding between salary, dividends, or a hybrid approach depends on your business profits, personal income needs, and long-term goals. At Fusion Accountants, we help UK directors create tailored remuneration plans that minimise tax, protect cash flow, and maintain pension eligibility.
- Set up your limited company with expert guidance.
- Calculate the most tax-efficient way to draw funds for 2025/26.
- Ensure compliance with HMRC and protect shareholder interests.
If you are not sure of this or wish to set one up, please speak to one of our Accountants in London or call us 0208 577 0200 or book a free consultation to get started, and we will answer any tax questions you may have, and we get you up and running in no time.
Tip: If your company has multiple shareholders or directors, include dividend rules in a shareholders’ agreement and a directors’ service contract to avoid disputes the rules for how you take money out of the company in a shareholder’s agreement and a director’s service contract so that everyone can understand.
FAQ’s
Q1. What is salary and how is it taxed in 2025/26?
Salary is income you pay yourself via PAYE. In 2025/26, the personal allowance is £12,570. Income above this is taxed at 20% (basic), 40% (higher), and 45% (additional rate). You’ll also pay National Insurance once earnings exceed £12,570. Salaries at or above the £6,396 Lower Earnings Limit count towards State Pension entitlement.
Q2. What are dividends and how are they taxed in 2025/26?
Dividends are payments from company profits after Corporation Tax has been deducted. The first £500 is tax-free, after which dividend rates apply: 8.75% (basic), 33.75% (higher), and 39.35% (additional). Dividends are not subject to NICs, which is why they are often more tax-efficient than salary.
Q3. Should I take salary or dividends as a company director?
Most directors use a hybrid approach — a salary set at either £6,396 (to maintain State Pension eligibility) or £12,570 (to use the full allowance if the Employment Allowance applies), with the rest as dividends. This combination usually balances tax efficiency, NIC savings, and pension planning.
Q4. What are the pros and cons of taking salary vs dividends in 2025/26?
- Salary pros: pensionable earnings, favoured by lenders for mortgages, deductible business expense.
- Salary cons: higher NIC and tax burden, less flexible.
- Dividend pros: lower tax rates, no NICs, flexible timing.
- Dividend cons: limited to post-tax profits, reduced dividend allowance (£500), not pensionable.
Q5. How do salary and dividends compare with a worked example in 2025/26?
For £50,000:
- All salary: Net take-home around £39,517, higher total company cost due to NICs.
- Salary + dividends mix: Net take-home around £46,764, saving over £7,000 in tax and NICs.
Q6. What special tax considerations apply in 2025/26?
Key issues include frozen tax thresholds (fiscal drag), new IR35 rules from April 2025, corporation tax bands and marginal relief, pension planning (only salary counts), and cash flow flexibility — dividends can be delayed, salaries cannot.
Q7. Is salary or dividends better if I plan to set up a limited company?
It depends on your goals. A hybrid approach is usually optimal, but factors like pension contributions, mortgage applications, IR35, and business growth may affect the balance. An accountant can model different scenarios to show which mix works best for your company.
