Small business owners face a crucial tax decision: salary versus dividends. How you pay yourself as a director of your own limited company can dramatically alter your tax bill, your borrowing power, and even your entitlement to maternity pay or a state pension. With tax rules shifting in 2026, the old certainties are eroding — and the choice is more nuanced than ever.
The most immediate difference lies in how each form of income is taxed. A salary is subject to income tax and both employee and employer national insurance contributions (NICs). For the 2026-27 tax year, the personal allowance remains frozen at £12,570, and the higher rate threshold is stuck at £50,270 — both until at least 2031. Above £100,000, the personal allowance is reduced by £1 for every £2 earned, vanishing entirely at £125,140. Dividends, meanwhile, are paid from profits that have already suffered corporation tax. They are free of national insurance, and dividend tax rates — though rising — remain lower than income tax rates. For 2026-27, the ordinary dividend rate is 10.75%, the upper rate is 35.75%, and the additional rate is 39.35%. The dividend allowance is just £500, meaning any dividends above that are taxable.
The cost of taking a salary has climbed sharply. From April 2025, employer NICs rose to 15%, and the secondary threshold — the point at which an employer starts paying NICs — fell from £9,100 to £5,000 per year. “Employer national insurance contributions have become more expensive,” notes Clare Stinton, senior personal finance analyst at Hargreaves Lansdown. “The rise in employer NICs and ongoing freezes in tax thresholds mean that the advantage of dividends is smaller than it used to be.” Even so, dividend tax rates also increased in April 2026 — basic and higher rate taxpayers now pay an extra 2p in the pound compared with 2025-26 — narrowing the gap further.
The hybrid approach: salary plus dividends
Most accountants recommend a middle path. A common strategy is for a sole director to take a salary around the personal allowance level of £12,570, and then supplement this income with dividends as profits allow. “Most directors land somewhere in between with a modest but consistent salary that covers essentials, with dividends drawn as profits allow,” says Subhashree Sadasivan, director of accounting at Rise Accounting. This hybrid structure typically works as follows: the salary portion sits within the personal allowance, so it generally avoids employee NICs and income tax. It does, however, attract employer NICs — but the increased employment allowance, now £10,500 with the £100,000 eligibility cap removed, can offset some of that cost for eligible businesses. The dividend portion then benefits from lower dividend tax rates compared with ordinary income tax. The result is often a lower overall tax burden than taking the entire amount as salary.
The calculation is becoming more complex. “The rise in employer NICs and ongoing freezes in tax thresholds mean that the advantage of dividends is smaller than it used to be,” says Stinton. Under the hybrid approach, the director maintains entitlement to state pension credits and certain benefits by taking a salary around the personal allowance — provided they have no other income eating into that allowance. The dividend allowance of £500 is a small buffer, but beyond that, every pound of dividends is taxed at the applicable dividend rate. For basic rate taxpayers in 2026-27 that means 10.75%; for higher rate taxpayers, 35.75%; and for additional rate taxpayers, 39.35%.
Corporation tax rates also matter. For the financial year beginning 1 April 2026, the main rate is 25% for companies with profits above £250,000. A lower rate of 19% applies to profits up to £50,000, with marginal relief in between. Because dividends are paid from post-tax profits, a higher corporation tax bill indirectly reduces the amount available to distribute.
Beyond tax: mortgages, maternity pay and pensions
Tax efficiency is only part of the picture. “Focusing on tax alone can be short-sighted,” warns Stinton. “Taking little to no salary could affect how much money you’re able to borrow for a mortgage.” Banks tend to view salary as more stable and predictable than dividends. Lenders typically require at least two years of accounts for self-employed directors, though some — such as Virgin Money — may look at a two-year average of net profit after tax plus director’s salary, using the lower year if the most recent is worse. A director taking a low salary may find their mortgage application approved for a smaller amount, or may face more limited options.
Maternity pay is another critical factor. Statutory maternity pay (SMP) is calculated as a percentage of salary, not dividends. For the 2025-26 tax year, SMP is 90% of average weekly earnings for the first six weeks, followed by a flat rate of £184.03 per week — or 90% of earnings if lower — for the remaining 33 weeks. For 2026-27, the flat rate rises to £194.32. “Statutory maternity pay is where a low salary creates a real problem,” says Sadasivan. “A director taking a £6,500 annual salary would receive significantly less than someone on a higher wage.” The same principle applies to other state benefits linked to earnings.
Pension contributions offer another route. Business owners can contribute to their pension through the company rather than from their salary. “Although your personal contributions will be limited to your salary, the business can pay in up to £60,000,” says Sarah Coles, head of personal finance at AJ Bell. “This is treated as a business expense, which cuts the amount of corporation tax due.” The annual allowance for pension contributions is £60,000 for 2026-27, and unused allowance from the previous three tax years can be carried forward. Company pension contributions are not capped by the director’s salary, making them particularly valuable for directors who take a low salary and rely on dividends.
Administrative burden and flexibility
Dividends come with their own paperwork. Directors must prepare dividend vouchers and board minutes. Unlawful dividends — those paid when the company lacks sufficient distributable profits — can attract HMRC scrutiny. For 2025-26, directors of close companies must disclose their company name, registration number, specific dividend amounts and highest percentage shareholding on their Self-Assessment returns, showing dividends from their own company separately.
Yet dividends also offer flexibility. “Business owners can take the money when it’s best for the business rather than a fixed sum each month,” says Coles. That can help manage cash flow. And while some lenders view dividends as less stable, Coles notes that “most lenders will consider dividends as part of your income when calculating affordability. Most of them will want to see one or two years’ worth of company accounts, to make sure the dividends are affordable for the business.”
Expert advice: review annually
No single strategy fits every business. The optimal salary level can also shift: the increased employment allowance to £10,500 and the removal of the £100,000 cap mean that, in some circumstances, taking a salary well above the personal allowance might be more tax-efficient if the employer NICs are offset by the allowance. The dividend allowance has been steadily reduced in recent years, making pure dividend extraction less attractive. At the same time, the freeze on personal allowances and thresholds drags more income into higher tax bands through fiscal drag.
The experts agree on one thing. “There is no one-size-fits-all approach,” says Stinton. Accountants recommend reviewing the remuneration structure annually — as tax rules continue to evolve — and tailoring the mix to minimise taxes while protecting pension entitlements, maternity leave and other personal finance concerns. “How you pay yourself as a business owner – through salary, dividends, or a mixture of both – can have a big impact on your tax bill and overall financial resilience,” she adds. “Each option is taxed differently and comes with trade-offs.”
