If you run your business through a limited company, one of the most common questions we hear from director-shareholders is a simple one: should I pay myself a salary, take dividends, or use a mix of both? For the 2026/27 tax year the answer matters a little more than usual, because dividend tax rates went up on 6 April 2026. Getting the balance right can make a meaningful difference to how much tax you and your company pay between you — so it is worth understanding how the two options actually work.
This guide walks through the moving parts in plain English. It is written with owner-managed limited companies in mind, where the same person is usually both the director and the main shareholder.
Salary and dividends are taxed very differently
The reason a mix often works is that salary and dividends are treated in completely different ways.
A salary is a business cost. It reduces your company's taxable profit, which in turn reduces its Corporation Tax bill. But salary is also subject to income tax and National Insurance, and paying it can trigger employer's National Insurance for the company too.
A dividend is a share of profit paid out to shareholders after Corporation Tax has already been charged. Dividends do not reduce your company's profit, and they carry no National Insurance — but they are taxed at their own rates on top of any other income you receive.
Because the two are taxed on different bases, the most efficient approach for many director-shareholders is a modest salary topped up with dividends, rather than relying on one alone. The right split depends on your wider income, so this is very much a "your circumstances" question.
What changed on 6 April 2026
The headline change for this tax year is that dividend tax rates rose by two percentage points at the start of 2026/27. For dividends above the tax-free allowance, the rates are now:
- Ordinary (basic) rate: 10.75% (up from 8.75%)
- Upper (higher) rate: 35.75% (up from 33.75%)
- Additional rate: 39.35% (unchanged)
The tax-free dividend allowance stays at just £500 for 2026/27. That is the amount of dividend income you can receive each year before any dividend tax applies — a long way down from the £2,000 it once was.
These increases do not change the basic strategy, but they do narrow the gap between salary and dividends slightly, which is exactly why it is worth reviewing your set-up rather than carrying last year's numbers over on autopilot.
The salary side
Most director-shareholders take a relatively low salary. There are two common reference points.
The first is the personal allowance of £12,570 — the amount you can earn before paying income tax. A salary at this level uses up the allowance efficiently, and because salary is deductible for the company it reduces Corporation Tax. It also comfortably exceeds the Lower Earnings Limit (£6,708 for 2026/27), so it counts as a qualifying year towards your State Pension even though little or no employee National Insurance is due.
The catch is employer's National Insurance. The threshold at which the company starts paying it — the secondary threshold — is only £5,000 a year, and the rate is 15%. So a £12,570 salary can generate employer's National Insurance on the slice above £5,000, unless the company can use the Employment Allowance (£10,500 for eligible employers). Sole director companies with no other employees generally cannot claim that allowance, which is why the ideal salary figure genuinely varies from one company to the next.
For most owners the Corporation Tax saved by paying a salary still outweighs the employer's National Insurance cost, but the maths is closer than it used to be — and it is worth running properly rather than guessing.
The dividend side
Once a sensible salary is set, further profit is usually drawn as dividends. Two rules matter here.
First, you can only pay a dividend out of retained profit — that is, profit left after Corporation Tax. If the company has not made enough profit, it cannot legally declare a dividend, and unlawful dividends can cause real problems down the line. Keeping clean records and proper dividend paperwork matters.
Second, your company pays Corporation Tax on its profits before any dividend is paid. The small profits rate is 19% on profits up to £50,000, rising to a main rate of 25% on profits over £250,000, with marginal relief in between. So the true cost of extracting profit as dividends is the Corporation Tax the company has already paid, plus the dividend tax you pay personally.
A simple way to picture it
Imagine a director who takes a £12,570 salary and then draws dividends to bring their total income up to around £50,000, staying within the basic-rate band. The first £500 of dividends is covered by the dividend allowance, and the rest is taxed at 10.75%. Push total income into the higher-rate band and the dividend rate jumps to 35.75%, so many owners deliberately keep drawings within the basic-rate band and leave surplus profit in the company for a year when it can be taken more efficiently — for example, spread across two tax years or paid into a pension.
This is where planning earns its keep. The order in which different types of income are taxed, the timing of dividends, pension contributions, and whether a spouse who is also a shareholder can use their own allowances can all shift the outcome.
Things people often get wrong
A few recurring pitfalls are worth flagging. Taking money out as a "dividend" when there is not enough profit to support it; forgetting that a director's loan account can build up and trigger extra tax; assuming the same salary figure is right every year despite changing thresholds; and overlooking that dividends still count as income when applying for a mortgage or assessing High Income Child Benefit and personal allowance tapers above £100,000.
None of these are reasons to avoid dividends — they are simply reasons to plan deliberately. And if you are still weighing up whether a company is even the right structure for you, our guide for sole traders is a useful companion read.
Get the balance right for your situation
The salary-versus-dividends decision is rarely one-size-fits-all, and the 2026/27 rate changes make a fresh look worthwhile. We help owner-managed companies set a tax-efficient, fully compliant remuneration plan and keep the paperwork straight.
If you would like us to review your salary and dividend mix for this tax year, get an instant quote or book a call and we will talk it through with you.
This article is general guidance, not personal tax advice. Your circumstances may differ, so please get in touch for advice tailored to you.