Why how you pay yourself matters
One of the biggest financial advantages of operating through a limited company is the flexibility you have over how you extract money from the business. Unlike a sole trader, who simply pays income tax and National Insurance on all profits, a limited company director can choose between salary, dividends, pension contributions, and other methods, each with different tax implications.
Done well, this flexibility can result in a significantly lower overall tax bill every year. Done poorly, or not thought about at all, and you may be paying far more than you need to.
The two main methods: salary and dividends
Salary
A salary paid through your company's payroll is subject to income tax and National Insurance Contributions (NICs), both employee's and employer's. This makes salary the least tax-efficient way to extract money from your company if taken in large amounts. However, paying a small salary has important advantages:
- It counts as a qualifying year for your State Pension
- It is a deductible business expense, reducing your company's corporation tax bill
- It can be paid at a level that avoids both income tax and NICs
Dividends
Dividends are payments made from the company's post-tax profits to its shareholders. They are not subject to National Insurance, which makes them significantly more tax-efficient than salary for extracting larger amounts of money. Dividends are taxed at lower rates than salary income: 10.75% for basic rate taxpayers, 35.75% for higher rate taxpayers (2026/27 rates).
However, dividends can only be paid from profits, you cannot pay a dividend if your company has not made sufficient profit after tax.
The optimal salary level for 2026/27
The most tax-efficient salary for most limited company directors in 2026/27 is typically set at one of two levels:
- £12,570, the personal allowance threshold. No income tax is due, but employer NICs are triggered above £5,000 and employee NICs above £12,570. Employer NICs are offset if the company can claim the Employment Allowance.
- £5,000, just at the employer Secondary Threshold. No employer NICs, but the salary still qualifies your National Insurance record for State Pension purposes.
Important: The optimal salary depends on your specific circumstances, including whether your company can claim the Employment Allowance, your total income, and other factors. These figures are illustrative. Always take advice tailored to your situation.
Topping up with dividends
Once you have drawn your optimal salary, you can top up your income with dividends up to the basic rate band (£50,270 in 2026/27, including your salary) at the lower dividend tax rate of 10.75%. Income above this threshold is taxed at 35.75%.
Each individual also has a dividend allowance of £500 in 2026/27, on which no dividend tax is due.
Pension contributions as an additional tool
Employer pension contributions made by your company are a highly tax-efficient way to extract money. They are deductible against corporation tax, are not subject to NICs, and grow in a tax-advantaged pension wrapper. For directors thinking about long-term financial planning, maximising pension contributions, particularly in higher-earning years, can significantly reduce the overall tax burden.
What about retained profits?
Not all profit needs to be extracted immediately. Leaving surplus profits in the company, especially if you expect a lower-income year ahead, allows you to draw dividends at a lower tax rate in a future year. This income-smoothing strategy is one of the most powerful available to limited company directors.
A worked example
Consider a director whose company makes £80,000 profit before their salary. In 2026/27, a straightforward approach might look like this:
- Salary: £12,570 (uses the full personal allowance; employer NI above £5,000 is typically offset by the Employment Allowance)
- Dividends: £37,700 (to the top of the basic rate band)
- Dividend allowance: £500 tax-free
- Retained in company: the remainder
The total personal tax on this structure would be substantially lower than if the same amount had been drawn as salary alone. The exact saving depends on your full circumstances, but the difference is often thousands of pounds per year.
Getting it right
The salary/dividend strategy is well-established and fully legal, HMRC accepts it as standard practice for owner-managed companies. But the optimal split varies depending on your income level, your company's profitability, your personal tax situation, and other sources of income.
At Claritax, we review your director remuneration strategy every year as part of our service, not just at year-end. If you're not sure whether your current setup is as tax-efficient as it could be, we're happy to take a look.
Want a personalised remuneration plan? Book a free consultation with our team and we'll review your current setup and show you where savings might be available.
Frequently asked questions
What salary should I pay myself as a limited company director?
Most directors pay either £12,570 (the personal allowance, no income tax due) or £5,000 (the employer NI secondary threshold, no employer NI due). £12,570 is often preferred since employer NI above £5,000 is usually offset by the Employment Allowance.
Why are dividends more tax-efficient than salary?
Dividends are not subject to National Insurance and are taxed at lower rates than salary (10.75% basic rate versus 20% income tax plus NI). However, dividends can only be paid from post-tax profits, unlike salary which is a deductible business expense.
How much is the dividend allowance?
£500 per person in 2026/27, tax-free regardless of your income tax band. Above that, dividends are taxed at 10.75%, 35.75% or 39.35% depending on which band they fall into once your salary has used up your personal allowance and basic rate band.
Should I leave profit in the company instead of drawing it out?
It can make sense if you expect a lower-income year ahead, since you can draw dividends at a lower tax rate later. This income-smoothing approach is one of the most useful tools available to limited company directors with fluctuating profits.
Does the salary and dividend split change every year?
The thresholds and rates can change with each Budget, so a split that was optimal last year may not be this year. We review director remuneration annually as part of our service, not just at year-end, so your setup keeps pace with the rules.