Salary vs dividends — the core tax difference
Limited company directors in the UK can extract money from their company three ways: salary, dividends, or pension contributions. Each one is taxed completely differently.
- Salary attracts personal income tax (20/40/45%) plus employee NI (8% / 2%) plus employer NI (15%). But salary is a deductible expense against corporation tax, so the company saves 19-26.5% on it.
- Dividends can only be paid from post-corporation-tax profit. So the company pays 19-26.5% CT first, then the director pays dividend tax (0% on the £500 allowance, then 8.75% / 33.75% / 39.35% by personal income band). No NI at all.
- Pension contributions made by the company are deductible against corporation tax and not taxed on the director (until withdrawal). For higher-rate earners, this is usually the most tax-efficient extraction.
The choice between salary and dividends comes down to the relative rates at your income level. For most directors, the answer is a small salary (at the personal allowance threshold) plus dividends for everything above.
2025/26 rates, side-by-side
| Income band | Salary tax | Dividend tax | Salary effective (incl. NI + CT) | Dividend effective (incl. CT) |
|---|---|---|---|---|
| £0 – £12,570 (PA) | 0% IT + 0% NI | 0% (allowance) | ~0% | ~19% (CT only) |
| £12,571 – £50,270 (basic) | 20% IT + 8% empNI + 15% emprNI | 8.75% | ~36% combined | ~26% combined |
| £50,271 – £100,000 (higher) | 40% + 2% empNI + 15% emprNI | 33.75% | ~52% combined | ~46% combined |
| £100k – £125,140 (PA taper) | 60% effective + NI | 33.75% + PA loss | ~67% combined | ~55% combined |
| £125,140+ (additional) | 45% + 2% empNI + 15% emprNI | 39.35% | ~57% combined | ~51% combined |
At every income level, the effective tax on dividends is meaningfully lower than the equivalent salary extraction. The "effective" rates account for corporation tax savings from salary being deductible vs corporation tax already paid before dividends.
Worked examples
£30,000 revenue (single director, no other income)
Sole trader on £30k: pays £3,486 income tax and £1,046 Class 4 NI → take-home £25,468. Effective rate: 15.1%.
Ltd director on £30k revenue (£12,570 salary + £17,430 - CT dividends): pays ~£3,312 CT + £648 dividend tax → take-home £26,040. Effective rate: 13.2%.
Ltd wins by ~£572. At basic-rate level, the dividend route is more tax-efficient than equivalent income for a sole trader.
£60,000 revenue (single director, no other income)
Sole trader on £60k: pays £11,432 income tax and £2,457 Class 4 NI → take-home £46,111.
Ltd director on £60k revenue: £47,616 take-home after CT (£9,012) and dividend tax (£3,372).
Ltd wins by £1,504.
£100,000 revenue (single director, no other income, full extraction)
Sole trader on £100k: take-home £69,311.
Ltd director on £100k revenue extracting all profit: take-home £67,221.
Sole trader wins by £2,090 at this band — because corporation tax marginal relief makes the effective CT rate 26.5% in the £50k-£250k band, and higher-rate dividend tax adds 33.75% on top. The combined ~52% rate beats salary at higher-rate but is close to the sole-trader rate.
However: if you don't need to extract all the profit personally, the Ltd route still wins decisively. £40,000 retained in the company stays at 19-26.5% corporation tax instead of being extracted at ~52% combined rate. The retained-vs-extracted question is the real story at higher incomes.
The £500 dividend allowance
Every UK taxpayer has a £500 dividend allowance — the first £500 of dividend income each tax year is tax-free, regardless of your income band. For a basic-rate-taxpayer director, that saves £43.75. For a higher-rate director, £168.75. For additional-rate, £196.75. Worth taking, but not a strategy in itself.
If your spouse is also a shareholder of your Ltd company, they get their own £500 allowance — so a husband-and-wife structure can shield £1,000 of dividends from tax each year. Combined with two personal allowances and two basic-rate bands, the lifetime savings from a real spousal-shareholder structure can run into tens of thousands.
When salary beats dividends
Three specific cases where higher salary beats more dividends:
- Mortgage applications. Most UK lenders calculate borrowing based on salary + a haircut on dividends (often 50%). Two years of higher director salary can materially increase your borrowing capacity. If you're planning a mortgage in the next 1-3 years, model salary-heavy strategies.
- Personal pension contributions. Personal (not company-paid) pension contributions are capped at the higher of £3,600 or your "relevant UK earnings" — which means salary, not dividends. If you want to make very large personal pension contributions, you need higher salary to support them.
- Tax credits / Universal Credit / SMP eligibility. Many benefits look at salary as the entitlement base, not dividends. If you're claiming benefits or about to need SMP for a parental leave, higher salary helps eligibility.