Salary vs Dividends: Which Is Better in 2026/27?

Here's the same dividend, taken by the same basic-rate taxpayer, nine years apart. In 2017/18, £10,000 of dividends came with a £5,000 tax-free allowance and a 7.5% rate on the rest. The tax bill was £375. In 2026/27, the allowance is £500 and the basic rate is 10.75%. The bill is £1,021. Same money. Nearly three times the tax.

That quiet shift is why the old advice, "take a small salary and pay yourself the rest in dividends", no longer works as a reflex. It still works for many directors. It just isn't automatic any more, and the reasons are worth understanding before you set your pay for the year.

I get asked about salary versus dividends in almost every first meeting with a new client. The question is always the same, and the honest answer always starts with "it depends". But "it depends" isn't much use on its own, so this guide sets out exactly what it depends on. We'll look at the numbers for 2026/27, the traps that catch directors out, and a simple set of questions you can use to decide.

If you'd like the wider picture of how directors are paid, including pensions and loans, our guide to how directors should pay themselves covers it. This article goes deeper on the salary-versus-dividends decision itself.

Is It Better to Take Dividends or Salary?

The short answer

For most owner-managed companies with no other staff, a modest salary plus dividends still comes out ahead of salary alone. But the margin has narrowed considerably, and for some directors the answer now goes the other way.

Why the comparison isn't as simple as it looks

The core difference is where the tax falls. Salary is a tax-deductible cost for your company, so it reduces corporation tax. It then attracts income tax and National Insurance, including 15% employer National Insurance on pay above £5,000. Dividends are paid out of profit that has already been taxed. They carry no National Insurance at all, but they do attract dividend tax, currently 10.75%, 35.75% or 39.35% above a £500 allowance.

So you're comparing two different routes. Route one is employer National Insurance, plus income tax and employee National Insurance. Route two is corporation tax, then dividend tax. Which is cheaper depends on your profit, your other income and your circumstances.

A worked example

Let's use realistic numbers. Take a sole-director company with £70,000 of profit before any director pay. There are no other employees, so no Employment Allowance is available. The director has no other income and makes no pension contributions. We'll use 2026/27 rates.

Option A: salary only. To use all £70,000, the salary works out at about £61,520, with roughly £8,480 of employer National Insurance on top. Corporation tax is nil, because there's no profit left. The director pays about £12,040 in income tax and £3,240 in employee National Insurance. Take-home pay is about £46,240.

Option B: £12,570 salary plus dividends. The salary costs the company about £13,705 including employer National Insurance. That leaves about £56,295 of taxable profit, which sits just inside the marginal relief band. Corporation tax comes to about £11,170, leaving about £45,125 to pay as a dividend. The salary is covered by the personal allowance, so no income tax or employee National Insurance is due on it. Dividend tax on £45,125 comes to about £6,650, because the top slice crosses into the higher rate band. Take-home is about £51,040.

The difference is about £4,800 a year in favour of the salary-plus-dividends route. Of the original £70,000, Option A loses about 34% in tax and Option B about 27%.

Notice what's happening in Option B, though. Some of that dividend is taxed at 35.75%, because it crosses the higher rate threshold. The gap would be wider if the director's income stayed within the basic rate band, and narrower if it went further into higher-rate territory. That's exactly why the answer isn't universal.

What changes the answer

Several things can tip the balance:

• Your profit level. Once profit falls inside the £50,000 to £250,000 marginal relief band, the corporation tax on the profit you pay out as dividends rises towards 26.5% on the margin.
• Employees. If you employ someone else, you may be able to claim the £10,500 Employment Allowance, which wipes out employer National Insurance up to that amount. That makes salary much cheaper.
• Other income. Rental income, a second job or savings interest all push your dividends up the tax bands.
• What you need the pay to do. Salary supports pension contributions, mortgages, and your State Pension record. Dividends don't.

When salary beats dividends

Salary tends to win when Employment Allowance is available, when you need earnings to support personal pension contributions, when a lender wants to see a steady income, or when statutory pay is a genuine consideration. If you're planning parental leave or a large mortgage application, it's worth running the numbers with a higher salary first.

What Is the Most Tax-Efficient Salary for Directors in 2026/27?

The three numbers that matter

Three thresholds drive this decision:

• ‍£5,000: the point at which employer National Insurance starts
• £6,708: the lower earnings limit, above which you earn a qualifying year for the State Pension
• £12,570: your personal allowance, and also the point at which employee National Insurance begins

Why £12,570 is the usual answer

For most sole-director companies without other staff, a salary of £12,570 is a sensible starting point. It uses your personal allowance in full, so no income tax is due. It's at the primary threshold, so no employee National Insurance is due either. The company pays about £1,135 of employer National Insurance, but the whole salary cost is deductible against corporation tax, which softens the blow.

I say "starting point" deliberately. It's a default, not a rule. The difference between £12,570 and a lower figure is fairly small in most cases, and there are situations where a different number wins.

When a lower salary makes sense

A salary of £6,708 secures a qualifying State Pension year without you paying any employee National Insurance, and costs the company only about £256 in employer National Insurance. A salary of £5,000 avoids employer National Insurance entirely. But because it falls below the lower earnings limit, it doesn't earn a qualifying year, so you may lose State Pension entitlement for no real tax gain. I rarely recommend it unless the director has other ways of building their record.

When a higher salary makes sense

If your company has other employees and can claim the £10,500 Employment Allowance, higher salaries cost much less in employer National Insurance. The allowance isn't available where the director is the company's only employee paid above the secondary threshold, so it's worth checking your own position. A higher salary also makes sense if you want to make sizeable personal pension contributions, because relief on those depends on your earnings, or if you need a stronger salary history for a mortgage.

A note on National Insurance for directors

Directors' National Insurance is usually calculated on an annual basis rather than month by month. If your payroll software applies it as though you were an ordinary employee, the deductions can be wrong during the year. It's a small point, but one of those things that goes quietly wrong in a do-it-yourself payroll.

What Is the Dividend Allowance for 2026-27?

£500, and no more

Every individual can receive the first £500 of dividend income each year at a 0% rate. It applies regardless of which income tax band you're in. It's a fraction of what it used to be. The allowance was £5,000 in 2017/18, then dropped to £2,000, then to £1,000, and reached £500 from April 2024. It has stayed there since.

It's a 0% rate, not a free band

This is a detail that surprises people. The £500 isn't an exemption that disappears from your income. It's a nil-rate band, and it still counts towards your basic rate band. So if your dividends push you across the higher rate threshold, the £500 uses up part of the room below it. It reduces the tax on those dividends, but it doesn't move the goalposts.

Each person has their own

A spouse or civil partner has their own £500, and their own personal allowance and basic rate band. That can make it sensible for a family member who genuinely owns shares to receive dividends. But the share ownership must be real. HMRC has specific rules aimed at arrangements where one person receives the income while someone else effectively controls it, so take advice before changing share structures purely to save tax.

The rates above the allowance

For 2026/27, dividends above £500 are taxed at 10.75% within the basic rate band, 35.75% within the higher rate band and 39.35% within the additional rate band. The bands themselves follow your total income: the basic rate band runs up to £50,270, the higher rate up to £125,140, and the additional rate applies above that.

Do Dividends Count as Income in the UK?

Yes, but as a different kind of income

Dividends are taxable income. They're reported on your Self Assessment return alongside salary, rent and interest. They sit as the top slice of your income, taxed after everything else, and they have their own set of tax rates.

Where they count, and where they don't

This is the part that trips people up. Dividends count as income for some purposes and not for others.

Dividends do count towards:

• Your income tax bands, and therefore which dividend rate applies
• Your adjusted net income, which decides whether your personal allowance starts to shrink above £100,000
• The High Income Child Benefit Charge, which starts once adjusted net income passes £60,000
• Lenders' affordability checks, though many will want to see two or three years of figures
• Most means-tested benefits

Dividends do not count as:

• Earnings for National Insurance, because none is due on them
• Relevant earnings for personal pension contributions
• Salary for statutory pay or your State Pension record

How they're reported

No tax is deducted at source on a dividend. It's reported through Self Assessment and paid by 31 January after the tax year ends. That's why it pays to set the tax aside on the day you pay yourself. Our director's tax guide covers the reporting timetable.

What Is the Dividend Trap?

One phrase, several traps

There isn't one official "dividend trap". The phrase gets used for several pitfalls that catch directors who take large dividends without planning. Here are the ones I see most often.

The £50,270 cliff

Dividends within your basic rate band are taxed at 10.75%. The moment they cross into the higher rate band, the rate jumps to 35.75%. There's no gentle slope. A director who takes £1,000 of dividends just below the line pays about £107.50 in tax on it. Take the same £1,000 just above the line, and it costs about £357.50. I've seen directors adjust a year-end dividend by a couple of thousand pounds and save several hundred in tax simply by spreading it across two tax years.

The £100,000 trap

Once your total income passes £100,000, your personal allowance shrinks by £1 for every £2 of income above that level, and disappears altogether at £125,140. On salary and other non-dividend income, that produces an effective rate of about 60% in that band. On dividends, the effective rate is different but similarly punishing, well over 50%. A well-timed pension contribution can pull your adjusted net income back under £100,000 and recover the allowance.

The Child Benefit trap

If you or your partner claims Child Benefit, adjusted net income above £60,000 triggers a clawback that removes the benefit entirely at £80,000. Dividends count. I've met directors who didn't know until a letter arrived that a year-end dividend had taken them over the threshold.

The reserves trap

A dividend can only be paid from distributable reserves, meaning realised profit after corporation tax. It isn't about how much cash is in the bank. If you pay a dividend without the reserves to support it, it's technically unlawful and can be reclassified as a director's loan. If that loan is overdrawn at your year end and isn't repaid within nine months, Section 455 tax at 35.75% applies. Our director's loan guide explains how this works.

The January trap

Because no tax is deducted at source, dividend tax builds up unnoticed. Then 31 January arrives, along with your tax bill and, if you're over £1,000, payments on account towards the following year. That can mean paying about a year and a half of tax in one go.

The no-salary trap

Taking no salary at all is legal, but it means no qualifying year for your State Pension, no earnings to support personal pension contributions, and no corporation tax deduction for pay. For most directors, a modest salary alongside dividends beats a dividends-only approach on every measure that matters.

What About Pension Contributions?

£100 in three different ways

Salary and dividends aren't your only options. An employer pension contribution can beat both for money you don't need to spend now.

Take £100 of company profit and a higher-rate taxpayer. Paid as a dividend, £81 is left after 19% corporation tax, and about £52 after dividend tax at 35.75%. Paid into your pension as an employer contribution, the full £100 goes in. It's deductible against corporation tax and avoids National Insurance.

When it wins, and when it doesn't

The catch is access. Pension money is locked away until your late fifties at the earliest, and is taxed when you draw it, though a portion can usually be taken tax-free. So it suits profit you don't need right now. It's the wrong choice for cash you need for a house deposit or to run the business. The annual allowance is £60,000 for most people, and you can carry forward unused allowance from the previous three years. Our pension contributions guide sets out the rules.

How Do I Decide?

Here's the five-question test I use with clients. It takes about ten minutes and gives you most of the answer.

1. What's my profit, and am I near £50,000 or £250,000? Inside the marginal relief band, planning is worth more. Our corporation tax guide explains why.
2. Do I have other staff? If so, check whether you can claim Employment Allowance.
3. What's my total personal income, and am I near £50,270, £60,000 or £100,000? Those lines change what an extra pound costs.
4. Do I need earnings for a pension, mortgage or State Pension record? If yes, salary matters more.
5. Do I need the cash now? If not, a pension contribution deserves a look.

Answer those five honestly and the right split usually becomes clear. Then review it every April, because thresholds move and so do your circumstances. Something that was best in 2024/25 may not be best now.

Salary versus dividends isn't a decision you make once and forget. Rates have shifted, allowances have shrunk, and the right split for a one-person company looks very different from that of a growing business with staff. If you'd like us to run your own figures, factoring in your actual profit, other income and plans, get in touch with the team at Cannon Accountants. It's a short conversation, and it's often worth thousands of pounds.

For the wider picture of how this fits alongside corporation tax, expenses, director's loans and everything else covered in this series, head back to our complete Limited Company Tax Guide 2026/27: Corporation Tax, Dividends & Director Tax →.

Disclaimer:

The content of this blog is for general informational purposes only and should not be considered professional tax advice. The information is correct at the time of publishing but may change following future UK budget announcements or updates to HMRC guidance. Individual circumstances vary, and tax obligations can differ based on your personal situation. We strongly recommend consulting with us or a qualified tax professional to receive advice tailored to your specific needs.