For the owner-director of a limited company, few decisions are as crucial—or as confusing—as how to extract profits. Do you take a straight Salary (PAYE) or distribute money via Dividends?
1. The Basics: What’s the Difference?
| Feature | Salary (PAYE) | Dividends |
| Source | Company’s Pre-tax Profits | Company’s Post-tax Profits |
| Tax Status (Company) | Allowable Business Expense (Reduces Corporation Tax) | Not an allowable expense |
| Taxes Paid (Personal) | Income Tax + National Insurance (Employee & Employer NIC) | Dividend Tax (Lower rates, no NIC) |
| Requirement | Must operate PAYE scheme (even for one director) | Must have sufficient distributable profits; must issue vouchers/minutes |
| Benefits | Counts for State Pension, makes loan/mortgage applications easier | Flexibility in timing and amount (profit-dependent) |
2. The Tax Efficiency Showdown
In most scenarios, a mix of salary and dividends is the most tax-efficient strategy for UK director/shareholders. The key is to strategically utilise your available tax-free allowances and lower tax bands.
The Recommended ‘Optimal’ Strategy: Small Salary + Balance as Dividends
The common advice is to pay a low salary, then take the rest of your income as dividends. The most tax-efficient salary level is usually set to utilise key National Insurance and Personal Allowance thresholds:
- The Target Salary: £12,570 (for 2024/2025).
Why £12,570 is the Sweet Spot:
- Zero Personal Tax: This amount is equal to the Personal Allowance (£12,570 for 2024/2025), meaning you pay £0 in Income Tax on the salary.
- No Employee NICs: This level is also aligned with the Primary Threshold for National Insurance, meaning you pay £0 in Employee NICs.
- State Pension Qualification: By earning above the Lower Earnings Limit (£6,500 for 2024/2025), this salary secures you a qualifying year toward your State Pension and other state benefits.
- Corporation Tax Reduction: Although the company pays Employer NICs on the portion above the Secondary Threshold (£9,100), the overall Corporation Tax saved by claiming the salary as a business expense typically outweighs the Employer NIC cost.
The Dividend Top-Up:
Once your Personal Allowance is used by the salary, you move onto dividends, which benefit from:
- The Dividend Allowance: The first £500 of dividend income is tax-free (2024/2025).
- Lower Tax Rates: Dividends are taxed at lower rates than salary income, and crucially, they are not subject to National Insurance.
| Personal Tax Band | Salary Income Tax Rate | Dividend Tax Rate |
| Basic Rate (Up to £50,270) | 20% | 8.75% |
| Higher Rate (£50,271 – £125,140) | 40% | 33.75% |
| Additional Rate (Over £125,140) | 45% | 39.35% |
3. Key Considerations Beyond Tax
Tax efficiency isn’t the only factor. Here’s a quick look at the other implications:
Salary Advantages:
- Mortgage & Lending: Lenders often prefer verifiable PAYE salary over unpredictable dividends when assessing affordability.
- Pension Contributions: Your company can make tax-efficient employer pension contributions based on your salary.
- R&D Tax Relief: Your salary counts as an eligible cost for R&D tax credit claims (dividends do not).
Dividend Advantages:
- Flexibility: You can choose when and how much to pay yourself (as long as there are profits).
- Simplicity (for higher earners): For high earners who have already used their NIC and personal allowances, dividends are significantly cheaper due to the avoidance of both Employee and Employer NICs.
- Multi-Shareholder Structuring: Dividends must be paid in proportion to shareholding, which can be beneficial if you split shares with a spouse/partner in a lower tax bracket.
Conclusion: Seek Professional Advice
While the default “low salary, high dividends” model is the winner for most small business directors, your optimal split depends entirely on your unique circumstances:
- Your company’s profit levels (dividends require distributable profits).
- Your household’s total income (including spouse/partner income).
- Your need for a predictable income stream (e.g., for a mortgage).
Contact us at SOKE Accounting to walk you through this personal tax year
This information is for guidance only. Tax rates and allowances change frequently, and getting the wrong balance can be costly. You should always consult a qualified accountant to tailor a strategy that maximises your specific tax efficiency for the current tax year.
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