How to Actually Get This Right

A client came to me a few months back at Edward Harris Accountants in Oldham with a question I hear constantly: “Why am I paying myself a tiny salary when I could just take everything as dividends and pay less tax?”

It’s a fair question. And the honest answer is: sometimes you’re right, sometimes you’re leaving money on the table, and sometimes the split you’ve been using for years is quietly out of date because the rules moved and nobody told you.

That last one is the killer, by the way. This area of tax changes almost every single year, and a split that made sense two years ago can be costing you real money now.

Why This Even Matters

If you run your own limited company, you’ve generally got two ways to get money out of it: pay yourself a salary through PAYE, or take dividends from company profits after Corporation Tax.

Each one gets taxed completely differently. Salary is hit with Income Tax and National Insurance, both on you personally and on the company side. Dividends skip National Insurance entirely, but they’re taxed at their own rates once you’re above the dividend allowance.

Because those two routes are taxed so differently, the mix you choose genuinely changes how much ends up in your pocket versus how much goes to HMRC. Get it wrong, and you’re not breaking any rules; you’re just paying more tax than you needed to.

The Numbers You Actually Need to Know

For the current tax year, the personal allowance sits at £12,570; income up to that level is generally free of Income Tax. The higher rate threshold kicks in at £50,270.

On the salary side, employee National Insurance is charged at 8% between £12,570 and £50,270, dropping to 2% above that. Your company also pays employer National Insurance at 15% on salary above the £5,000 secondary threshold, though this is deductible against Corporation Tax.

Dividends work differently. You get a £500 dividend allowance taxed at 0%, and above that, dividend tax is charged at 10.75% at basic rate and 35.75% at higher rate, following a two percentage point increase that came into effect from April this year. That rise matters more than people realise it genuinely shifted the maths for a lot of directors who hadn’t touched their split since the old rates.

Have you actually checked which rates apply to your current split, or are you still running on last year’s numbers? I ask because I see this constantly, and it’s an easy thing to miss when you’re busy running the business itself.

So What’s the “Optimal” Dividend Split, Then?

For most single-director companies, the standard approach is a salary set at £12,570, exactly matching the personal allowance, topped up with dividends for the rest.

Here’s why that figure specifically. It uses your full personal allowance so none of it goes to waste. It sits right at the primary threshold, so you pay no employee National Insurance on it. And crucially, it still banks you a qualifying year towards your state pension, which dividends alone never do.

The salary itself is also deductible against Corporation Tax, which softens the blow of the employer NI you’ll pay above £5,000. In my experience, once clients see the actual Corporation Tax saving laid out next to the small NI cost, the £12,570 figure stops feeling arbitrary and starts feeling obvious.

But It’s Not Always That Simple

Here’s what most people miss: the £12,570 answer isn’t universal, and treating it as a one-size-fits-all rule is where a lot of directors go wrong.

If your company qualifies for the Employment Allowance, generally available where you’ve got at least two people on payroll earning above the secondary threshold, which includes two director-shareholders both taking a salary, you can currently wipe out up to £10,500 of employer National Insurance. When that applies, a higher salary often becomes more attractive, because the NI cost that used to make dividends the obvious winner simply isn’t there anymore.

Your Corporation Tax rate matters too. Companies with profits up to £50,000 pay the small profits rate of 19%. Above £250,000, you’re at the main rate of 25%. In between, marginal relief applies, and the effective rate can land around 26.5% on profits within that band, which actually makes salary deductions more valuable, not less, because you’re saving tax at a higher effective rate.

If you’ve got associated companies, that changes your thresholds too, since the bands get split between them. I’ve had clients genuinely surprised to learn that a second dormant company they’d forgotten about was affecting their Corporation Tax banding.

Example

I worked with a husband-and-wife team running a small consultancy through their limited company. Both were directors, both worked in the business, and they’d been taking identical low salaries with large dividend top-ups for years, based on advice from years earlier.

Once the Employment Allowance became relevant to their situation because they both genuinely worked in the business as directors, we recalculated everything. Pushing their salaries up meant more employer NI on paper, but the allowance wiped almost all of it out, and the extra Corporation Tax deduction from the higher salaries saved them more than the old low-salary approach ever had.

It wasn’t a massive windfall. But it was a few thousand pounds a year they’d been leaving on the table simply because nobody had gone back and rechecked the numbers against their actual situation.

Don’t Forget What Salary Buys You Beyond Tax

This is the bit that gets lost when people focus purely on the tax comparison. A proper salary does things dividends simply can’t.

It builds your state pension entitlement, year on year. It gives lenders something concrete to look at if you’re applying for a mortgage; dividend income alone can be a harder sell, especially with irregular or lumpy amounts. And it keeps you contributing towards things like Statutory Sick Pay eligibility and other employment-linked benefits that dividends don’t touch at all.

If you’re planning to buy a house in the next couple of years, or you’re thinking about your pension seriously, that’s a conversation worth having before you chase the purely tax-efficient number. The cheapest route on paper isn’t always the smartest one for your wider financial picture.

My Honest Take

I think too many directors set their salary and dividend split once, early on, and then never touch it again even as rates, allowances, and their own circumstances change year after year. That’s the actual mistake, far more than picking the “wrong” number to begin with.

Dividend tax has moved upwards more than once in recent years, allowances have shrunk, and thresholds shift with every Budget. A split that was genuinely optimal three years ago could easily be costing you money right now without you noticing, because the bill still gets paid and nobody flags that it could’ve been lower.

If you haven’t had your salary and dividend split properly reviewed in the last year, that’s the one thing I’d actually push you to sort before your next dividend declaration, not because it’s a huge crisis, but because it’s one of the easiest wins in the entire tax system, and it’s sitting there unclaimed for a lot of directors who simply haven’t looked.