Striking the right balance between salary and dividends can make a considerable difference to your tax efficiency as a director.
With the 2025/26 tax year ushering in several key changes, it’s essential to reassess your remuneration strategy to ensure you’re not leaving money on the table.
(Read Time: Approx. 4 minutes)
Topics Discussed:
- Key tax changes from April 2025 and their impact on director pay
- When to favour salary, when to favour dividends, and how other personal factors influence the mix
No One-Size-Fits-All Solution
For owner-directors, choosing between salary and dividends isn’t a one-off decision but an ongoing balancing act.
The right structure will vary depending on each individual’s circumstances, business setup, and income levels.
Generally, dividends are more tax-efficient for paying out profits, but this may not always be optimal, especially if certain thresholds or allowances apply.
Flexibility is key to making the most of available reliefs and avoiding unnecessary liabilities.
Factor 1: The Scale of Personal Income
If you earn other income outside of your company, (such as rental income, investment returns or a second job) this will reduce the availability of your tax-free allowances.
With income tax bands still frozen for 2025/26, this ‘fiscal drag’ means you could be pushed into higher tax brackets even if your income stays the same in nominal terms.
For many, it becomes even more crucial to time and structure income carefully.
The Dividend Allowance remains at just £500, so going heavy on dividends means you’re likely to encounter basic, higher, or additional dividend tax rates sooner. As of 2025/26, these remain at 8.75%, 33.75% and 39.35% respectively.
Factor 2: Availability of the Employment Allowance
If your company qualifies for the Employment Allowance (now increased to £10,500) it can effectively eliminate Employer’s National Insurance on part of your salary.
However, this allowance isn’t available to sole-director companies with no employees.
If you can structure the business to include additional employees (even family members working genuinely in the business), it could be worth utilising this benefit.
Given the Employer NI rate has increased to 15%, making good use of this allowance becomes even more valuable.
This could make a modest salary more attractive than it has been in prior years.
Factor 3: Corporation Tax Rate Payable
The effective Corporation Tax rate your company pays affects the value of profits left over for dividends.
With the main rate now potentially reaching 25%, high-profit companies will face stiffer deductions before any dividend distributions.
However, paying a salary reduces your taxable profits, which in turn may save Corporation Tax.
So, while salaries are subject to Income Tax and National Insurance, they do carry the advantage of reducing your corporate tax bill.
The decision then becomes a balancing act: how much tax do you save at the corporate level versus how much you pay personally?
Factor 4: Splitting Dividend Income with a Spouse or Partner
For married couples or civil partners, sharing company shares can significantly improve tax efficiency.
If both partners have access to the £500 dividend allowance and their own personal income tax bands, the tax savings can be considerable.
In practice, this means careful structuring of shareholdings and the use of alphabet shares if appropriate.
Of course, any such arrangement must pass HMRC’s scrutiny, genuine ownership and rights must be attached to the shares, and the use of settlements legislation should be carefully considered.
Factor 5: The Role of Salary in Qualifying for Tax Reliefs
If your company is claiming Research & Development (R&D) tax relief, salaries form part of the qualifying expenditure.
Dividends, on the other hand, do not. Therefore, for companies heavily reliant on innovation or R&D activities, maintaining a higher level of director salary may be justifiable, even if it isn’t the most efficient in pure take-home terms.
Similarly, making pension contributions is often more straightforward from salary, especially where auto-enrolment obligations apply or when you want to maximise annual allowances.
2025/26 Key Tax Thresholds and Allowances at a Glance
Here’s a quick snapshot of some crucial thresholds relevant to your decision-making for the current tax year:
- Personal Allowance: £12,570 (unchanged)
- Dividend Allowance: £500 (unchanged)
- Lower Earnings Limit (NI): £6,500
- Primary Threshold (Employee NI): £12,570
- Secondary Threshold (Employer NI): £5,000 (reduced from £9,100)
- Employment Allowance: £10,500 (increased from £5,000)
- Employer NI Rate: 15% (up from 13.8%)
- Employee NI Rates: 8% basic, 2% higher
These changes highlight the importance of regularly reassessing your remuneration strategy.
The increased Employer NI rate, coupled with a lower secondary threshold, makes higher salaries costlier for companies, while the frozen personal allowance means individuals risk being dragged into higher tax brackets even if their income stays flat.
Summary
Balancing salary and dividends isn’t just about minimising tax, it’s about creating a strategy that aligns with your income needs, your company’s circumstances and current tax legislation.
From taking advantage of the Employment Allowance to understanding how R&D relief interacts with salary costs, the optimal solution is highly individual.
The 2025/26 tax year brings changes that shift the balance again, so now is the time to review your approach.
If you’re unsure what blend of salary and dividends works best for your situation, get in touch with us today.
Fill out our form here for any questions, email us at info@taxexpert.co.uk, or message us on our WhatsApp for out of office hours.
Kind regards,
Ilyas Patel