Once you run your business through a limited company rather than as a sole trader, the profit belongs to the company, not to you. Getting it into your own bank account is a separate decision, and the two main routes, salary and dividends, are taxed in completely different ways. The mix you choose changes the total tax bill, sometimes by a few hundred pounds and sometimes by a few thousand, which is why the salary-and-dividend question comes up at almost every year-end review for owner-managed companies in Harrow.
There is no single right answer, because it depends on your other income, the company's profit level and whether the business can claim the Employment Allowance. What does not change is the underlying mechanics, and once you understand those the right split for your own situation usually becomes clear.
How a salary is taxed
A salary paid to a director is an employment cost. The company runs it through PAYE, the director pays income tax and employee National Insurance on it personally, and the company pays employer National Insurance on top. The salary is a deductible expense for the company, so every pound of salary reduces the profit that corporation tax is charged on. That deduction is the salary route's main attraction, and it is why a salary is rarely dropped to zero even when dividends do most of the heavy lifting.
The thresholds that matter sit close together. The personal allowance for 2026/27 is £12,570, so income up to that level carries no income tax. For employers, National Insurance starts once earnings pass the secondary threshold, which HMRC's rates and thresholds for employers sets at £5,000 a year for 2026/27, with employer National Insurance charged at 15% above it. The lower earnings limit of £6,708 a year matters too, because a salary at or above it preserves your entitlement to the state pension and contributory benefits without necessarily creating a National Insurance bill for the employee.
Why a small salary still earns its place
Even where the salary triggers a little employer National Insurance, the corporation tax saved on the deduction often more than covers it, particularly for a company paying 25% or sitting in the marginal band. Many single-director companies also qualify to set a salary at a level that builds a qualifying year for the state pension while keeping the personal tax cost low. Where a company employs more than one person it may also claim the Employment Allowance, which removes up to £10,500 of employer National Insurance for the year and changes the arithmetic again. Whether a single-director company qualifies for that allowance is a point worth checking rather than assuming.
How dividends are taxed
A dividend is a distribution of profit the company has already paid corporation tax on. It carries no National Insurance at all, for either the company or the director, which is the feature that makes it attractive. The cost is that dividends are paid out of post-tax profit, so the company cannot deduct them, and the director then pays dividend tax personally on anything above the allowance.
For 2026/27 every individual has a tax-free dividend allowance of £500. Above that, dividends are taxed at rates that depend on which income tax band they fall into once stacked on top of your other income. HMRC's guide to tax on dividends confirms the rates for the year, which rose by two percentage points from April 2026.
Two points catch directors out. The dividend allowance is not an extra tax-free amount on top of the personal allowance in the way people often picture it; dividends covered by an unused personal allowance are tax-free, and the £500 allowance then sits on top, but the band a dividend lands in is decided by your total income for the year. And the rate is set by where the dividend stacks, so the same dividend can be partly basic rate and partly higher rate if it straddles the £50,270 higher-rate threshold.
Why the company tax position changes the answer
Dividends look cheaper than salary at first glance because they avoid National Insurance, but that comparison ignores the corporation tax already paid before the dividend can be declared. A salary is paid before corporation tax, a dividend is paid after it. So the real comparison is the total of corporation tax plus personal tax on each route, not the personal tax alone.
The corporation tax rate the company pays therefore feeds straight into the decision. A company comfortably inside the 19% small profits rate keeps more of each pound before distribution than one paying the 25% main rate or sitting in the marginal band, which shifts the balance between the two routes. The detail of those rates and where the £50,000 and £250,000 limits sit is set out in our explanation of the 25% main rate and 19% small profits rate, and it is worth reading alongside this one because the two decisions are really one decision.
A typical split for a small company
For a single-director company with profit in the basic-rate region, a common pattern is a modest salary set around the personal allowance or the relevant National Insurance threshold, with the rest of the required income taken as dividends. The salary captures the corporation tax deduction and protects state pension entitlement; the dividends carry no National Insurance and use the £500 allowance and the lower dividend rates before any higher-rate dividend tax bites.
That pattern is a starting point, not a rule. A director with significant income from elsewhere, a buy-to-let portfolio or a second job, may already be a higher-rate taxpayer before a single dividend is declared, which pushes every dividend into the 35.75% band and changes the sums. A company that needs to retain profit to fund growth may distribute very little in a given year. And the level of profit decides whether leaving money in the company to be taxed only at corporation tax, rather than extracting it, is the better short-term outcome.
Other ways to extract value
Salary and dividends are the headline routes, but they are not the only ones. Employer pension contributions are a deductible expense for the company and are not taxed as your income when paid, which makes them one of the most efficient ways to move money out of a profitable company. Genuine business costs met by the company, and the expenses a director can legitimately reclaim, reduce taxable profit without being remuneration at all; our guide to small business tax deductions covers what does and does not qualify. These sit alongside the salary-and-dividend split rather than replacing it.
Getting the paperwork right
However you split the money, the dividend side has to be done properly. A dividend can only be paid out of distributable profit, meaning profit left after corporation tax and after any earlier losses. Paying a dividend the company cannot support creates an unlawful dividend that HMRC can recharacterise, often as a loan to the director with its own tax consequences. Each dividend needs a board minute and a dividend voucher dated in the year it is paid, and the salary needs to run through PAYE in real time. The tax saving from a sensible split is only secure if the records back it up.
Frequently asked questions
Is it always better to take dividends rather than salary?
No. Dividends avoid National Insurance but come out of profit that has already paid corporation tax and carry no deduction for the company, so a salary up to a sensible threshold is usually retained to capture the deduction and protect state pension entitlement. The efficient answer is almost always a mix, with the exact split depending on profit level and your other income.
Do I pay tax on dividends inside the £500 allowance?
No. The first £500 of dividend income in 2026/27 is taxed at 0%. It still counts towards your total income when working out which band your other dividends fall into, so it is best thought of as a nil-rate band rather than income that disappears.
Can I change the split partway through the year?
Yes. Salary is usually set at the start of the year and run monthly through PAYE, but dividends are declared as and when there is distributable profit, so the dividend element is flexible. Reviewing the position before the company year-end, while there is still time to act, is where the planning value sits, which is why this is a standard part of a year-end conversation with your accountant.