The most tax-efficient way to take money
For many limited company directors, the most tax-efficient way to take money from the company is not simply “salary” or “dividends”. It is often a mix of both.
Salary and dividends are taxed differently. A salary is paid through payroll and can create Income Tax and National Insurance responsibilities. Dividends are paid to shareholders from company profits after Corporation Tax and are taxed under the dividend tax rules.
That means the right answer depends on your company profits, your other income, whether the company has employees, your National Insurance position, available allowances and how much money you need personally.
This article explains the main differences between salary and dividends, where mistakes happen, and why limited company directors should review their position each tax year.
What Is a Director’s Salary?
A director’s salary is pay from the company for work carried out as a director or employee.
If your company pays you a salary, the company normally needs to run payroll. GOV.UK explains that if a company pays salary, expenses or benefits, it must register as an employer and take Income Tax and National Insurance from salary payments where due. You can read the GOV.UK guidance on taking money out of a limited company.
Salary is usually treated as an allowable business expense for the company, provided it is paid wholly and exclusively for business purposes. This means salary can reduce the company’s taxable profit before Corporation Tax is calculated.
However, salary can also create PAYE, employee National Insurance and employer National Insurance costs, depending on the amount paid and the thresholds that apply.
What Are Dividends?
Dividends are payments made to shareholders from company profits.
A dividend is not a wage. It is a return to shareholders because they own shares in the company. This is an important distinction because dividends are taxed differently from salary.
GOV.UK explains that a dividend is a payment a company can make to shareholders if it has made a profit. The company must not pay out more in dividends than its available profits from current and previous financial years. You can read the official guidance on limited company dividends.
Dividends also need to be recorded properly. The company should declare the dividend, keep minutes and prepare dividend vouchers.
This matters because taking dividends without enough available profit can create problems. If a company cannot afford the dividend but the director still takes the money, the payment may be treated as a director’s loan that needs to be repaid.
The Main Difference Between Salary and Dividends
The main difference is how each payment is taxed.
Salary is paid before company profit is taxed. It can reduce company profit for Corporation Tax, but it may create PAYE and National Insurance liabilities.
Dividends are paid after Corporation Tax. They do not reduce company profit for Corporation Tax. GOV.UK states that dividends cannot be counted as business costs when working out Corporation Tax. You can read this under taking money out of a limited company.
Dividends are not subject to National Insurance in the same way as salary, but shareholders may pay dividend tax personally.
For the 2026/27 tax year, GOV.UK says the dividend allowance is £500. Dividend income above the allowance is taxed depending on the taxpayer’s Income Tax band. The dividend tax rates for 2026/27 are 10.75% for basic rate taxpayers, 35.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. You can check the current GOV.UK page on tax on dividends.
Why Directors Often Use a Mix of Salary and Dividends
Many owner-managed companies use a combination of salary and dividends because each has different tax effects.
A salary can help use the director’s Personal Allowance and may help maintain a National Insurance record, depending on the salary level. The standard Personal Allowance for 2026/27 is £12,570, although it can reduce where income is above £100,000. You can check the current GOV.UK guidance on Income Tax rates and Personal Allowances.
Dividends can then be used to extract further profits, provided the company has enough retained profit and the dividends are properly declared.
This does not mean the same salary and dividend split is right for everyone. A director with other employment income, rental income, pension income or investment income may need a different approach from a director whose only income comes from their company.
The company’s position also matters. If profits are low, dividends may not be possible. If the company has higher profits, Corporation Tax rates and marginal relief may also affect planning.
Corporation Tax Also Matters
Dividends are paid from profits after Corporation Tax, so the company’s Corporation Tax position should be considered before deciding how much to distribute.
For Corporation Tax years starting 1 April 2026, GOV.UK lists the small profits rate at 19% for companies with profits under £50,000 and the main rate at 25% for companies with profits over £250,000. Marginal relief can apply between the lower and upper limits. You can check the official GOV.UK page on Corporation Tax rates and allowances.
This is one reason dividend planning should not be looked at in isolation. The personal tax rate on dividends is only part of the picture. You also need to consider the company tax paid before dividends are available.
National Insurance and Directors’ Salaries
National Insurance is one of the key differences between salary and dividends.
GOV.UK explains that directors are classed as employees and pay National Insurance on annual income from salary and bonuses over the relevant threshold. Companies also pay employer’s National Insurance on directors’ salaries where due. You can read the GOV.UK guidance on National Insurance for company directors.
This means increasing salary may increase National Insurance costs. However, salary can also affect entitlement to certain state benefits and the State Pension record, depending on the level of earnings and the director’s wider position.
A common mistake is focusing only on Income Tax and ignoring National Insurance. For directors, the salary decision should consider both.
Common Mistakes With Salary and Dividends
Taking dividends when there are no profits
Dividends can only be paid from available profits. If the company does not have enough profit, taking money as “dividends” can create director loan issues.
Forgetting the paperwork
Dividends should be properly declared and recorded. Dividend vouchers and board minutes should be kept even where there is only one director.
Assuming dividends are always best
Dividends can be efficient, but they are not always the best answer. The company’s profits, the director’s other income, Corporation Tax, National Insurance and future plans all matter.
Ignoring other shareholders
Dividends are paid to shareholders according to their share rights. If there is more than one shareholder, dividend planning needs to consider share structure and company law.
Not reviewing the position each tax year
Tax rates, thresholds and company profits change. A salary and dividend mix that worked last year may not be the best option this year.
Should You Take Salary, Dividends or Both?
For many limited company directors, the answer is both.
A modest salary may help use available allowances and keep payroll records clear. Dividends may then be used to extract profits after Corporation Tax, provided the company has enough available reserves.
But the right mix depends on the full picture.
Before deciding, directors should consider:
- company profit before tax
- retained profits available for dividends
- other personal income
- Income Tax band
- dividend allowance
- employee and employer National Insurance
- Corporation Tax position
- pension contributions
- benefits in kind
- cash flow needs
- whether there are other shareholders
The most tax-efficient answer is not always the most practical answer. Cash flow, mortgage applications, pension planning, business reinvestment and future growth can all affect the decision.
Final Thoughts
Salary and dividends are both legitimate ways for a limited company director to take money from a company, but they are not interchangeable.
Salary is paid through payroll and can reduce company profit for Corporation Tax, but it may create PAYE and National Insurance costs. Dividends are paid to shareholders from post-tax profits and may be taxed personally under the dividend tax rules, but they do not reduce Corporation Tax.
The best approach is usually to review the numbers each tax year rather than rely on a fixed rule.
Need help deciding the right salary and dividend mix for your limited company? Merranti Accounting can review your company profits, payroll position and personal tax exposure.
