This comes up more than you’d think. A director takes money out of the company, feels fine about it, then the first self assessment bill lands and it is larger than expected.
Salary vs dividends is not about chasing clever tricks. It is about understanding the rules well enough to stay compliant, avoid cash flow shocks, and pay only the legal minimum tax.
Recent changes, especially the reduction in the dividend allowance, mean more owner-directors now pay dividend tax than they did a few years ago. If you have been taking dividends out of habit, it is worth a calm review.
The headline change is the dividend allowance. It used to cover a meaningful chunk of dividend income. It is now only £500 per year. That pushes more dividends into taxable territory, even for directors with modest drawings.
At the same time, a lot of businesses have seen profits rise while costs have risen too. That combination makes planning more important, because the wrong extraction pattern can create an avoidable tax bill or a cash squeeze at the wrong time.
A good director pay strategy does three things:
Dividends come from profits, after corporation tax
A dividend is a payment a limited company makes to its shareholders out of profits. In simple terms, the company earns profit, pays corporation tax, then it can distribute some of what is left as dividends.
If the company does not have sufficient distributable profits, it cannot pay a dividend legally. That point matters more than most people realise, because dividends are often taken based on bank balance, not on profits.
Salary is paid to you as an employee or director through payroll. Dividends are paid to you because you own shares.
If you are a director-shareholder, you can take both. That is the common setup for owner-managed companies.
For the 2025/26 tax year, the dividend allowance is £500. That means the first £500 of dividends you receive is taxed at 0%.
Two quick clarifications that prevent confusion:
After the dividend allowance is used, dividends are taxed at these rates in 2025/26:
Tax band Dividend tax rate (2025/26) Basic rate 8.75% Higher rate 33.75% Additional rate 39.35%
Dividend tax is not calculated in isolation. Your dividends sit on top of your other income, such as:
That means the same dividend payment can be taxed at 8.75% for one person and 33.75% for another, purely because of where they sit in the tax bands.
Dividends are often more tax efficient than salary because they are not subject to National Insurance. That does not make dividends “better” in every situation, but it explains why a blended approach is common for directors.
The government has announced that dividend tax rates are expected to increase by around 2 percentage points from April 2026 for basic and higher rate taxpayers.
If you have flexibility over when dividends are declared and paid, timing can matter. The right answer depends on:
Good planning here is boring in the best way. It reduces surprises.
Many directors set a salary level that makes practical use of their personal allowance, then take further income as dividends. This keeps PAYE simple and creates a regular, mortgage-friendly payslip.
Salary normally attracts National Insurance for the employee and employer, depending on the level. Dividends do not. That difference is one of the main reasons the combined approach can reduce the overall tax cost of taking money out of a company.
A small salary can be run consistently through payroll. Dividends can be varied based on profits and cash needs.
That matters for time-poor founders. A strategy that is “perfect” on paper but hard to run month to month usually falls apart under pressure.
This is the big one. A dividend has to be supported by distributable profits. Cash in the bank is not the same thing as profit in the accounts.
If you take dividends without profits, it can create problems ranging from reclassification as a director loan to unexpected tax outcomes.
Dividends do not have tax deducted at source. If you take £10,000 in dividends, you do not automatically “feel” the tax cost.
Setting aside a percentage in a separate savings pot can prevent the January tax bill becoming a stress point.
A common misunderstanding is treating the whole dividend payment as taxed at one rate. In reality, parts of your dividend can fall into different bands once it stacks on top of your other income.
Dividends should be documented properly. That normally includes:
This is not paperwork for paperwork’s sake. It is what makes the extraction defensible and tidy.
Some directors take money out informally, then later try to “label it” as dividends. If the timing and paperwork do not line up, it can create a messy director loan account and extra admin at year end.
Practical example: salary £12,570 and dividends £40,000
Here is a simplified illustration to show how dividend tax for business owners in the UK typically works. Exact figures depend on the full income picture, and Scotland has different income tax rates for non-dividend income, so treat this as a rough guide.
Assume salary of £12,570. That is commonly aligned with the personal allowance.
In this simplified example, that means little or no income tax on the salary itself.
Dividends are £40,000.
The first £500 is taxed at 0% because of the dividend allowance, leaving £39,500 taxable dividends.
With total income in this example (salary plus dividends) sitting within the basic rate band, the taxable dividends are broadly charged at 8.75%.
Estimated dividend tax: £39,500 × 8.75% = £3,456.25.
That is the sort of number that catches people out if no money has been set aside during the year.
Depending on your overall self assessment position, you may also need to consider payments on account, which can bring forward part of next year’s tax. That is one reason a director can feel like they are paying “double” in January the first time they have a meaningful dividend tax bill.
If profits are growing, dividends often grow too. The step up from basic to higher rate dividend tax is material, so it is worth forecasting before you take a large dividend.
Growth needs cash. A dividend strategy that empties the bank account can look fine on your personal side and create stress in the business two months later when VAT or payroll is due.
Pension contributions can be part of a director’s wider planning, and they often interact with taxable income levels. This is an area where a clear plan beats ad hoc decisions.
If drawings are uneven, the admin tends to get messy. A simple monthly routine, supported by tidy records, is usually calmer and more tax efficient over the year.
At AVMK Accountants, I focus on keeping things clear and controlled through the year. That means up to date bookkeeping, sensible forecasting, and plain-English guidance on what you can take out, and when, without walking into an avoidable tax bill.
If your business is growing and you want clearer guidance on how to structure salary, dividends, and tax planning, you can learn more about how we support growing businesses here: Accountant for Growing Businesses.
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