Dividends vs Salary: Planning for the 2026 Tax Hike

Dividends vs. Salary: Which is Best for You?

As a director of a UK limited company, choosing how to pay yourself is one of the most critical financial decisions you will make. The two primary methods are paying a salary (as an employee) or distributing profits as dividends (as a shareholder).

While salary offers security and state benefits, dividends are generally taxed at a lower rate, offering greater tax efficiency. The optimal strategy often involves a blend of both. This guide breaks down the advantages and disadvantages of each to help you structure your income effectively for the 2025/26 tax year.

The Case for Dividends: Tax Efficiency

Dividends are paid from the company’s post-tax profits. For many business owners, they are the preferred method of extracting value due to their favourable tax treatment.

Advantages of Dividends

• Lower Tax Rates: Dividend tax rates (8.75% basic, 33.75% higher – increasing to 10.75% and 35.75% from 6 April 2026) are significantly lower than Income Tax rates on salary.
• No National Insurance: Unlike salary, dividends attract zero National Insurance contributions (NICs) for both the individual and the company.
• Dividend Allowance: You can earn the first £500 of dividend income tax-free (2025/26 allowance).

Disadvantages of Dividends

• Profit Dependent: Dividends can only be paid if the company has made a profit. If the company makes a loss, you cannot legally pay a dividend.
• Irregular Income: Dividends are often paid at irregular intervals, making personal budgeting harder compared to a fixed monthly salary.
• No State Benefits: Dividend income does not count towards your National Insurance record, meaning it does not help you qualify for the State Pension.

The Case for Salary: Stability and Benefits

Paying yourself a salary through PAYE makes you an employee of your own company. This route offers security and access to statutory benefits.

Advantages of Salary

• State Pension & Benefits: A salary above the Lower Earnings Limit (£6,500) builds your qualifying years for the State Pension and entitles you to contributory benefits.
• Corporation Tax Relief: Unlike dividends, a director’s salary is a tax-deductible business expense, reducing your company’s Corporation Tax bill.
• Financial Stability: A regular monthly income makes personal budgeting easier and is often preferred by mortgage lenders as proof of stable income.

Disadvantages of Salary

• Higher Tax Burden: Salary is subject to higher Income Tax rates and attracts both Employee and Employer National Insurance Contributions.
• PAYE Admin: Running a payroll scheme adds administrative complexity and compliance requirements to your business operations.

Which Will You Choose?

The choice isn’t binary. For most directors, the answer lies in balancing the tax efficiency of dividends with the security of a salary.

The 2025/26 Context & Forward Planning

The Autumn Budget 2025 has confirmed that income tax thresholds will remain frozen until April 2031. This “fiscal drag” means that as you increase your salary or dividends to match inflation, more of your income may be pushed into higher tax bands.

Crucially, with Dividend Tax rates set to rise to 10.75% (Basic) and 35.75% (Higher) from April 2026, the 2025/26 tax year represents a critical window of opportunity. The optimal strategy is generally to take a salary of £12,570 (to use your Personal Allowance) and maximise dividend withdrawals before the rate hike takes effect.

Q1: Can I pay myself dividends if my company made a loss?

No. Dividends can only be paid out of distributable profits. If your company has made a loss or has no retained earnings, paying a dividend is illegal and may be reclassified as a director’s loan.

Q2: Does a salary reduce Corporation Tax?

Yes. A director’s gross salary (and any Employer NICs paid) is an allowable business expense, which reduces the company’s taxable profit and its Corporation Tax liability. Dividends do not reduce Corporation Tax.

Q3: What is the most tax-efficient salary for a sole director?

For 2025/26, a salary of £12,570 is generally the most efficient. It uses up your tax-free Personal Allowance, avoids Employee NICs, and secures a State Pension qualifying year.