| Feature | Salary | Dividends |
|---|---|---|
| Income tax (basic rate) | 20% | 8.75% |
| Income tax (higher rate) | 40% | 33.75% |
| Employee NI | 8% (£12,570–£50,270); 2% above | 0% |
| Employer NI | 15% above £9,100 | 0% |
| Corporation tax deductible? | Yes — salary reduces company profit before CT | No — paid from post-CT profit |
| Builds NI record? | Yes (if ≥ Lower Earnings Limit ~£6,396) | No |
| Pension contribution base? | Yes — counted as relevant earnings | No |
| Requires company profit? | No | Yes — distributable reserves required |
| First £500 | Taxed at standard rates | 0% dividend allowance |
For a director extracting income above what is covered by the personal allowance (£12,570), dividends are typically more tax efficient than additional salary. The reason: no National Insurance on dividends.
Consider an extra £10,000 of income in the basic rate band, after the personal allowance is already used by salary:
| Route | Gross to company | Tax paid | Director receives |
|---|---|---|---|
| Extra salary | £10,000 (deductible → saves 19% CT = £1,900) | £2,000 IT + £800 NI + £1,500 employer NI − £1,900 CT saving = £2,400 net tax cost | £7,200 net |
| Extra dividend | £10,000 pre-tax profit (CT 19% = £1,900 → £8,100 post-CT dividend) | £8,100 at 8.75% = £708.75 dividend IT | £7,391 net |
The dividend route delivers ~£191 more to the director per £10,000 of company income in the basic rate band — a modest but consistent advantage driven entirely by the NI saving.
At the higher rate, the advantage is larger in absolute terms:
| Route | Tax rate (combined) | Director keeps per £1 gross company income |
|---|---|---|
| Higher rate salary | ~55% (40% IT + 2% NI + 15% employer NI, CT offset) | ~52p |
| Higher rate dividend | ~47% (25% CT + 33.75% dividend IT on remainder) | ~54p |
Despite dividends' NI and income tax advantages, salary wins in two critical situations:
The full new State Pension in 2026/27 is £11,502/year. To receive the full amount, you need 35 qualifying NI years. A qualifying year requires salary (or other NI-eligible income) of at least the Lower Earnings Limit (~£6,396/year).
Dividends build no NI record whatsoever. A director who pays themselves only dividends for 20 years accumulates zero qualifying years during that period. Taking a salary of at least £6,396 (or ideally £9,100 — the Secondary Threshold) ensures each year is a qualifying year at no NI cost.
Annual pension contributions are limited to 100% of "relevant earnings" — which includes salary but not dividends. A director with no salary and only dividend income cannot make personal pension contributions above the basic £3,600 gross/year limit.
For high-earners wanting to maximise pension contributions (annual allowance £60,000), a salary creates the relevant earnings base that allows contributions up to £60,000/year. A director on £12,570 salary and £87,430 dividends can still contribute up to £60,000 to a pension — based on the £60,000 annual allowance, but their relevant earnings is only £12,570 so personal contributions are capped at £12,570 personally (the employer can contribute the rest).
Salary is deductible from company profits before corporation tax is calculated. Dividends are paid from post-corporation-tax profits. This is often misunderstood as making salary "equally efficient" — but the NI consideration means dividends are still more efficient above the personal allowance threshold in most cases.
| CT rate | Effect on salary vs dividend decision |
|---|---|
| 19% (profits ≤ £50,000) | Salary deduction saves 19% CT — partially offsetting employer NI cost; dividends still often win overall |
| 25% (profits ≥ £250,000) | Salary deduction saves 25% CT — larger CT saving makes salary more competitive, but dividends often still win above NI thresholds |
| Marginal relief zone (£50k–£250k) | Effective CT rate up to ~26.5% — salary deduction most valuable here; carefully model with an accountant |
As CT rates have risen (from 19% flat in 2022/23 to a two-rate system), the relative efficiency of salary has increased — but for most owner-managed companies at the 19% small profits rate, dividends above the PA threshold remain more efficient overall.
The overall marginal rate on £1 of company income extracted as salary vs dividend:
| Income zone | Marginal rate: salary route | Marginal rate: dividend route (19% CT) | Dividend advantage |
|---|---|---|---|
| Within personal allowance (£0–£12,570) | Employer NI 15% above £9,100; no IT; no employee NI | 19% CT; 0% dividend IT | Salary usually wins — lower overall cost within PA |
| Basic rate band (£12,570–£50,270) | 20% IT + 8% employee NI + 15% employer NI − 19% CT saving ≈ 34% | 19% CT + 8.75% on remainder ≈ 26% | Dividends ~8% more efficient |
| Higher rate band (£50,270–£125,140) | 40% IT + 2% employee NI + 15% employer NI − 19% CT saving ≈ 48% | 19% CT + 33.75% on remainder ≈ 46% | Dividends ~2% more efficient |
The dividend advantage is largest in the basic rate band and narrows significantly at the higher rate. At additional rate (above £125,140), the advantage is ~3–4% but a 25% CT rate would reduce this further.
Dividends can only legally be paid from distributable reserves — retained profits after corporation tax. If your company has no accumulated profit, you cannot pay a dividend, even if it has cash in the bank (from a loan, capital injection, or director's loan).
For this reason, most directors maintain a reasonable salary throughout the year (regardless of profitability) and declare dividends at year-end once profit is confirmed by accounts.