Salary vs Dividends: Why the Old Rules of Thumb No Longer Apply

For years, the standard advice for owner-directors of small limited companies was simple: pay yourself a small salary up to a threshold, then take the rest as dividends. It was a reliable way to minimise National Insurance while keeping things simple.

That advice hasn't disappeared — but it's no longer the whole story. A series of changes over the past few years has turned what used to be a quick back-of-envelope calculation into a genuine planning exercise, one that depends on your company's profit level, your other personal income, and how close you are to several increasingly important tax thresholds. Here's what's changed, and why it matters.

1. Employer National Insurance is no longer a rounding error

Since April 2025, employers pay Class 1 National Insurance at 15% on earnings above a Secondary Threshold of £5,000 a year — down from £9,100 previously. That's a lower starting point and a higher rate than a few years ago, and both remain in place for 2026/27.

This matters directly to the salary decision because a salary above £5,000 now triggers employer NI on a much larger slice of it than it used to. The classic "pay a salary equal to the NI threshold" strategy still works to minimise employer NI, but the numbers behind it have moved, and the cost of pushing salary higher is greater than it was.

2. Employment Allowance helps — but many director-only companies can't claim it

The Employment Allowance — currently up to £10,500 — can wipe out employer NI entirely for many small businesses, and the old £100,000 liability cap on eligibility has been removed, so more businesses qualify than before.

The catch: companies where the director is the sole employee are specifically excluded. If you're a single-person contractor limited company with no other staff on payroll, you generally can't claim it — which means your salary decision has to be made without this relief in mind. If you do have at least one other employee earning above the threshold, the allowance can make a higher salary far more attractive than it looks on paper, because employer NI on the first tranche of payroll costs may be sheltered entirely. This is one of the main reasons the "right" salary level can vary so much between one small company and another with an almost identical profit level.

3. Corporation tax now has two rates — and a nasty middle zone

Since April 2023, corporation tax hasn't been a flat rate. For 2026/27:

• 19% on profits up to £50,000 (small profits rate)

• 25% on profits above £250,000 (main rate)

• Profits in between are taxed via marginal relief, which tapers the rate smoothly between the two — but produces an effective marginal rate of around 26.5% on profits within that band

The thresholds are also divided between associated companies, so if you control more than one company, your effective small-profits threshold could be much lower than £50,000.

Why this matters for salary vs dividends: salary is a deductible business expense that reduces the company's taxable profit, while dividends are paid out of profit after corporation tax. If your company's profits sit in that £50,000–£250,000 marginal band, an extra pound of salary is effectively saving corporation tax at up to 26.5%, not the headline 25% — which changes the arithmetic compared to a company safely under £50,000 or comfortably over £250,000.

4. Dividend tax has gone up, and the allowance has shrunk

The tax-free Dividend Allowance is down to £500 (from £2,000 just a few years ago, and £5,000 before that). On top of that, dividend tax rates increased by 2 percentage points from April 2026:

• 10.75% basic rate

• 35.75% higher rate

• 39.35% additional rate

Dividends are still generally more NI-efficient than salary — there's no employee or employer NI on dividend income — but the personal tax gap between salary and dividends has narrowed compared to a few years ago. The right split now depends much more on modelling actual numbers than applying a rule of thumb.

5. The £100,000–£125,140 "trap" is catching more people than ever

This is probably the single biggest factor that's changed the calculation in recent years, and it's exactly the one you flagged: the tapering of the Personal Allowance.

Once your adjusted net income exceeds £100,000, you lose £1 of your £12,570 Personal Allowance for every £2 earned above that threshold — until it disappears completely at £125,140. Because you're paying 40% higher-rate tax on that income and simultaneously losing tax-free allowance, the effective marginal rate on income in this band is around 60%.

Because tax thresholds have been frozen for several years while profits, salaries and dividend income have generally drifted upward, far more director-shareholders now find some or all of their income falling into this band than would have a few years ago — even ones who wouldn't previously have thought of themselves as "high earners." If your total income (salary + dividends + anything else) is anywhere near £100,000, this taper deserves more attention than almost any other single factor in your salary/dividend split, because it can make additional income from either source dramatically less efficient than it appears at first glance.

6. Other personal income changes the picture completely

This is where generic advice really breaks down, because the right answer depends on what else is happening on your personal tax return:

• Savings interest: Basic-rate taxpayers get a £1,000 Personal Savings Allowance, higher-rate taxpayers get £500, and additional-rate taxpayers get none at all. There's also a separate £5,000 starting rate band for savings, but it only applies if your non-savings income is low enough — it shrinks fast as salary and dividend income rise. With savings interest rates higher than they were a few years ago, many directors now have meaningful bank interest that pushes them into a higher tax band or eats into their savings allowance, which in turn affects how much salary or dividend income they can take before crossing into higher-rate tax.

• Rental income, freelance income, or a second job: any of these count toward your total income for both the higher-rate threshold and the £100,000 Personal Allowance taper.

• High Income Child Benefit Charge: if you or your partner claims Child Benefit, the charge starts clawing it back once either partner's income exceeds £60,000, and it's gone completely by £80,000. A dividend that tips you over £60,000 can cost more in lost Child Benefit than it delivers in cash.

• Pension annual allowance tapering: high earners (broadly, adjusted income over £260,000) can see their pension annual allowance reduced too, though this affects fewer owner-directors than the Personal Allowance taper.

• Marriage Allowance: if your spouse or civil partner is a non-taxpayer, transferring part of your Personal Allowance to them can be worth a small amount — but it's lost automatically if your own income moves you into higher-rate tax.

7. Free childcare hours: a cliff edge, not a taper

If you have young children, there's a threshold that catches out even directors who are otherwise careful about their tax position: the £100,000 adjusted net income limit for Tax-Free Childcare and the government's funded 15 or 30 hours of free childcare.

This one deserves particular attention for three reasons:

• It's tested per parent, not per household. If either parent's adjusted net income goes over £100,000, that parent fails the test — even if their partner earns very little. A single director taking a large dividend in one tax year can lose the benefit for the whole family, regardless of the other parent's income.

• There's no taper. Unlike the Personal Allowance (which fades out gradually between £100,000 and £125,140) or the High Income Child Benefit Charge (which claws back gradually between £60,000 and £80,000), the childcare threshold is a hard cliff edge. Adjusted net income of £100,001 loses the benefit entirely, in exactly the same way as £150,000 would.

• Dividends count in full, alongside salary, savings interest, rental income, and anything else that forms part of adjusted net income. A director who keeps salary modest but takes a large dividend in December to cover a big personal expense can easily blow through £100,000 for the year without realising it until reconfirmation time.

For families with childcare costs, this can be worth thousands of pounds a year — the 30 hours entitlement alone is worth several thousand pounds annually in most areas, before even counting the separate Tax-Free Childcare top-up of up to £2,000 per child (or £4,000 for a disabled child). Because HMRC reconfirms eligibility every three months based on your expected income for the full tax year, an unexpected dividend, bonus, or a good year of savings interest can trigger a loss of entitlement — and potentially a requirement to repay support already received.

If you're a director with young children and your income is anywhere near six figures, this threshold arguably deserves as much attention as the Personal Allowance taper itself, precisely because there's no gentle warning zone — you're either under the line or you've lost the benefit outright. Timing dividends carefully across tax years, or keeping some retained profit in the company rather than drawing it all in a single year, can be the difference between qualifying and not.

8. Why there's no single "right answer" anymore

Put all of this together and you can see why salary vs dividends has stopped being a formula and become a genuine optimisation problem. The right balance for any individual director depends on:

• Where the company's profit sits relative to the £50,000 and £250,000 corporation tax thresholds

• Whether the company has other employees and can claim Employment Allowance

• Whether the director has other companies (affecting associated-company thresholds)

• The director's total personal income from all sources — salary, dividends, savings interest, rental income, and anything else

• Whether that total income is anywhere near £60,000 (Child Benefit), £100,000 (Personal Allowance taper and the free childcare cliff edge), or £125,140 (where the Personal Allowance taper finishes)

• Personal circumstances like a spouse's income, pension planning, or plans to sell the business (where retained profits and Business Asset Disposal Relief come into play)

Two companies with identical profits, run by directors with identical salaries on paper, can have completely different "optimal" salary/dividend splits once you factor in a savings account, a rental property, or a partner's income.

The bottom line

The mechanics of salary vs dividends haven't changed in principle — salary is a company expense that reduces corporation tax and attracts income tax and NI; dividends come from taxed profit and attract only dividend tax. What's changed is that the thresholds surrounding both routes have multiplied, frozen in place while incomes have risen around them, and started interacting with each other in ways that are easy to miss.

If your numbers are simple — modest profit, no other income, well clear of £100,000 — the traditional low-salary, dividend-topped-up approach is probably still close to optimal. But if you're near any of the thresholds above, it's worth running the actual numbers for your specific situation each year rather than relying on last year's answer, since a frozen personal allowance combined with rising profits can quietly shift you into a different, less efficient position without anything else changing.