Salary or dividends? Crack the code to paying yourself tax-efficiently

Paying yourself from your limited company isn’t as simple as clicking ‘transfer’ – but get it right, and you could unlock serious tax savings.

Unlike sole traders, limited company directors can’t just dip into business profits whenever they please. That’s because your company is legally a separate entity from you, and pulling money out for personal use requires a little more thought – and the right method. The good news? With the right approach, you can structure your remuneration in a way that’s both legal and tax-efficient.

As a company director and shareholder, you can pay yourself in different ways. The two most common methods are a director’s salary and shareholder dividends. But which payment method should you choose – a salary, dividends, or both? 

This article explains what to consider when deciding how to pay yourself through a company. The tax rates and thresholds mentioned below relate to the 2025-26 tax year, which runs from 6 April 2025 to 5 April 2026. 

Paying yourself a director’s salary

Most company directors pay themselves a salary through their company. Your director’s salary will be subject to Income Tax if your annual taxable earnings from all sources (i.e. from the company and elsewhere) exceed the standard Personal Allowance of £12,570.

The Personal Allowance is the amount of income you can earn tax-free in a year. However, it reduces by £1 for every £2 of taxable income a person earns above £100,000. Therefore, if your annual taxable income is £125,140 or more, your Personal Allowance for the year will be zero.

Income Tax and National Insurance rates 

The table below shows the UK Income Tax rates you will pay on your director’s salary if you have a standard Personal Allowance:

Tax band	Tax rate	Taxable income
Basic rate	20%	£12,571 to £50,270
Higher rate	40%	£50,271 to £125,140
Additional rate	45%	over £125,140

The tax bands and rates are different if you live in Scotland. You will instead pay the following Scottish Income Tax rates on your director’s salary above the standard Personal Allowance:

Tax band	Tax rate	Taxable income
Starter rate	19%	£12,571 to £15,397
Basic rate	20%	£15,398 to £27,491
Intermediate rate	21%	£27,492 to £43,662
Higher rate	42%	£43,663 to £75,000
Advanced rate	45%	£75,001 to £125,140
Top rate	48%	over £125,140

In addition to Income Tax, you will pay employee Class 1 National Insurance contributions (NIC) on your director’s salary if it exceeds the Primary Threshold, which is also currently £12,570 per year. The NIC rates are as follows:

Employee Class 1 NIC rate	Annual earnings threshold
8%	£12,571 to £50,270
2%	over £50,270

These National Insurance rates and thresholds are the same in all parts of the UK, including Scotland.

Your company will also be liable to pay 15% employer’s (‘secondary’) Class 1 National Insurance contributions on your salary earnings above the Secondary Threshold, which is currently £5,000 per year. 

Registering your company as an employer 

If you decide to take a director’s salary, you may need to register your company as an employer with HMRC and enrol for Pay As You Earn (PAYE). This requirement applies even if you’re the only person working for your company. 

PAYE is an HMRC system that collects Income Tax, National Insurance contributions, and other deductions (e.g. Student Loans) from employment. These deductions are then paid to HMRC monthly. 

You’ll need to register as an employer if your company does (or intends to do) any of the following:

• Pay any employees (including company directors) at least £96 per week (£5,000 per year)
• Employ someone (including any company director) who has another job or is already receiving a pension
• Provide expenses or benefits to employees or directors
• Hire subcontractors for work in the construction industry

Once registered, you can operate PAYE as part of your company payroll to record your director’s salary, calculate deductions, and report your pay and deductions to HMRC on or before each payday. 

Issuing dividends from shares

As a company shareholder, issuing dividends is an effective way to pay yourself from a limited company when it generates profit. You can’t take dividends if your company doesn’t have any distributable profits.

The board of directors (or sole director, if applicable) must also agree to the issuance of dividends, and you should retain enough profit as working capital to ensure your company can meet its liabilities as they fall due.

• Business insurance for startups
• UK business laws you need to know
• 13 changes to UK company law – from 4 March 2024 

Dividend income is reported and taxed differently from salary income. It is not paid through PAYE or subject to Income Tax or National Insurance contributions. Instead:

• Dividends are distributed from company profits after the deduction of Corporation Tax, so you will pay lower personal tax rates on any dividend income you receive.
• You must declare and pay tax on dividend income through Self Assessment. This involves completing a Self Assessment tax return at the end of the tax year and paying any tax you owe to HMRC.

You won’t pay any tax on dividend income that falls within your Personal Allowance. There is also a dividend allowance of £500, so the first £500 of dividends will be tax-free. This means you can earn £13,070 in dividends tax-free if you don’t have any other sources of income. 

Above the Personal Allowance and dividend allowance, you will pay the following rates of dividend tax based on your Income Tax band:

• Basic rate – 8.75%
• Higher rate – 33.75%
• Additional rate – 39.35%

To work out your tax band and the applicable dividend tax rates, you need to add your total dividend income to your other taxable income (e.g. director’s salary, income from property, earnings from other jobs, gains from the disposal of assets).

These tax rates and thresholds for dividend income apply across the UK. Therefore, even if you pay Scottish Income Tax on your director’s salary, you will pay tax on dividends based on UK Income Tax bands and thresholds.

Paying yourself a combination of salary and dividends

Many company owners pay themselves a combination of a director’s salary and shareholder dividends rather than one or the other. Doing so ensures the most tax-efficient manner of extracting money from a company.

Some directors also utilise other methods, such as directors’ loans. However, this is beyond the scope of the article. We recommend seeking advice from an accountant before arranging a director’s loan.

What’s the most tax-efficient combination of salary and dividends?

The most tax-efficient salary and dividend combination for company directors and owners changes every tax year. It also depends on your situation – for example, whether you have income from other sources (i.e. outside the company) or need a higher salary for a mortgage, personal loan, or income protection cover.

However, the strategy remains the same if your company has made a profit – pay yourself a small salary up to either: 

• The NIC Secondary Threshold (£5,000 per year / £417 per month) – if your company is not eligible to claim Employment Allowance 
• The NIC Lower Earnings Limit (£6,500 per year / £542 per month) – if you want to minimise NICs but still qualify for certain benefits and the State Pension 
• The NIC Primary Threshold (£12,570 per year) / £1,048 per month) – if your company is eligible to claim Employment Allowance  

Then, take the rest of your income as dividends, depending on how much distributable profit (if any) your company has available. Remember that you can’t issue dividends if your company has not made a profit. 

By structuring your remuneration in such a way, you will pay less personal tax than if you were to take all your income as a director’s salary. Moreover, you won’t pay employee NICs on your salary, and your company will be able to avoid, minimise, or offset any employer’s National Insurance liability. 

Reducing your company’s National Insurance liability

Your company may be eligible to claim Employment Allowance if you pay at least one employee (who’s not a director) or two directors above the NIC Secondary Threshold. This would enable you to reduce the company’s employer NIC liability (if applicable) by up to £10,500 in the 2025-26 tax year. 

While your company won’t pay employer NICs on your salary if it’s below £5,000 per year, it’s worth bearing in mind if you want to take a higher salary and your company is eligible to claim. 

Unfortunately, a single-director company with no employees cannot claim Employment Allowance. GOV.UK provides more information on the Allowance, including eligibility requirements and how to claim. 

Protecting your entitlement to the State Pension and benefits 

Paying National Insurance contributions entitles you to certain social security benefits, notably the State Pension. This is an essential consideration when deciding whether to pay yourself a salary (and how much).  

Unless you have other sources of income on which National Insurance is paid (or treated as having been paid), you need to take a director’s salary of at least £6,500 per year (the NIC Lower Earnings Limit) to protect your entitlement to certain benefits and the State Pension. 

You won’t pay Income Tax or employee NICs on this salary amount, but you’ll still get the benefits of paying. This means you will build up qualifying years for the State Pension and protect your National Insurance record.

However, remember that the company will be liable to pay employer NICs on any portion of your salary above £5,000 per year. 

If you take a director’s salary below the Lower Earnings Limit (or no salary at all), these earnings alone won’t count towards your NIC record. 

Reducing your company’s Corporation Tax bill

Paying yourself a small director’s salary can reduce your company’s Corporation Tax liability. Since wages and salaries are tax-deductible business expenses, your company can claim tax relief on your director’s salary against its taxable profits.

This is another reason why paying yourself a salary and dividends combination is more beneficial than taking all your income as dividends. Unfortunately, you can’t count dividends as a tax-deductible business expense (because they’re paid from profits after tax), but the dividend allowance and lower personal tax rates are designed to counter this to an extent.

The amount of Corporation Tax you can save by taking a director’s salary will vary depending on how much profit your company makes. The current Corporation Tax rates are as follows:

• 19% (small profits rate) – applies to companies with annual profits up to £50,000
• 25% (main rate) – applies to companies with annual profits above £250,000

If your profits are between £50,000 and £250,000, you can claim Marginal Relief. This relief provides for a gradual increase in the effective Corporation Tax rate between 19% and 25%.

Registering for Self Assessment

You usually need to register for Self Assessment and file an annual Self Assessment tax return with HMRC if you receive: 

• Dividend income from shares 
• More than £2,500 net (or more than £10,000 gross) from UK property or land  
• Any taxable benefits (e.g. a company car)  
• Gains (profit) from the disposal of assets and you need to pay Capital Gains Tax
• More than £10,000 from savings and investments  
• Foreign income  
• More than £1,000 from self-employment (e.g. from a sole trader side hustle)  
• Any other untaxed income above £2,500 per year 

For example, you must register and submit a Self Assessment tax return if you pay yourself dividends from your company. However, you won’t need to register or submit a tax return if all your income is taxed through PAYE (i.e. as a director’s salary). 

How we can help

The administrative requirements of running a limited company can be time-consuming and somewhat daunting. Our Full Company Secretary Service can help ease this burden by preparing your director and shareholder resolutions, which are required when approving and issuing dividend payments.

1st Formations‘ Company Secretarial Team can also arrange PAYE registration with HMRC. Once registered, your company (or payroll provider) can report your director’s salary, calculate any deductions of Income Tax and National Insurance contributions, and send payroll information to HMRC each payday. This PAYE registration service is available for £24.99 plus VAT. 

Thanks for reading

Salaries and dividends generally play different roles within a company. There are benefits and costs to both, as we’ve outlined throughout this post. 

• Salaries are tax-deductible against company profits, but you’ll pay Income Tax and NIC above a certain level. If eligible for the Employment Allowance, your company may be able to reduce any employer’s NIC liability on your salary.
• Dividends are paid from company profits after the deduction of Corporation Tax, and you can’t count them as a business expense. But you’ll pay lower personal tax rates, and they’re not subject to NIC.

There is a lot to consider. Nevertheless, as a company director and shareholder, a combination of salary income and dividends will allow you to extract money from your company in the most tax-efficient manner possible.

We recommend speaking to an accountant for expert advice and guidance. They are best placed to devise the most tax-efficient remuneration structure for your personal circumstances while ensuring your company remains compliant.

Please feel free to comment below. You can also find more limited company guidance and business advice by exploring the 1st Formations Blog.