If you run your own limited company, one of the first questions you will face every year is how to pay yourself. Take too much as salary and you and the company hand over a large slice to Income Tax and National Insurance before you have even spent a penny. Take everything as dividends and you may miss out on pension credits, mortgage affordability checks, and in some cases pay more tax than necessary once dividend rates and allowances are factored in. Most director-shareholders muddle through with whatever their accountant did last year, without understanding why. This article walks through the mechanics in plain English and shows, with real numbers, how a small salary combined with dividends usually beats a salary-only approach for extracting profit from an owner-managed company.
Why this decision matters more than you think
The difference between extraction methods is not a rounding error. On a company with £50,000 of profit available to pay its director-shareholder, the gap between the least and most tax-efficient route can be close to £4,000 in the director’s pocket, with no change to the underlying business performance. Get this wrong every year for five years and you have quietly given away roughly £20,000 that could have funded a pension, paid down a mortgage, or been reinvested in the business.
Salary and dividends, explained without the jargon
A salary is pay for work done as an employee or director. It is a cost to the company, so it reduces the profit the company pays corporation tax on. But it also triggers Income Tax and employee National Insurance for the director personally, and employer National Insurance for the company on top. Salary counts as relevant earnings for pension contributions and helps build a qualifying year towards the State Pension.
A dividend is a distribution of profit to shareholders. It is only paid after the company has already paid corporation tax on that profit, so it is not a deductible expense. There is no National Insurance on dividends at all, and dividend tax rates are lower than equivalent Income Tax rates on salary. The catch is that dividends can only be paid out of retained, post-tax profit, and they do not count towards pension contribution limits or National Insurance qualifying years.
Some companies can also claim the Employment Allowance, which cuts employer National Insurance by up to £5,000 a year. Since April 2016 this has not been available where the sole employee is also the only director, so many one-person companies cannot use it. That is one reason the small-salary-plus-dividends structure works so well once you run the numbers, as the worked example below shows.
Worked example: extracting £50,000 from your company
Suppose your company has £50,000 of profit available before any payment to you as director, and there are no other shareholders to consider. You are comparing two routes: paying it all as salary, or paying a small salary equal to the personal allowance of £12,570 and drawing the rest as dividends. All figures use 2024/25 rates: employer National Insurance at 13.8% above the £9,100 secondary threshold, employee National Insurance at 8% above £12,570, basic rate Income Tax at 20%, the small profits rate of corporation tax at 19%, a dividend allowance of £500, and dividend tax at 8.75% within the basic rate band.
| Option 1: Salary only | Option 2: Salary £12,570 + dividends | |
|---|---|---|
| Gross salary | £45,041 | £12,570 |
| Employer’s National Insurance | £4,959 | £479 |
| Employee’s National Insurance | £2,598 | £0 |
| Income Tax on salary | £6,494 | £0 |
| Corporation tax | £0 | £7,021 |
| Dividend paid | £0 | £29,930 |
| Tax on dividend | £0 | £2,575 |
| Net cash to director | £35,949 | £39,925 |
| Total extracted from the £50,000 pot | £50,000 | £50,000 |
The table shows the headline results: the mixed salary-and-dividend route puts £3,976 more into the director’s pocket from exactly the same £50,000 of company profit. The calculation below shows how the £39,925 figure for Option 2 is actually built up, step by step.
| Company profit available for extraction | £50,000 |
| Less: director’s salary | -£12,570 |
| Less: employer’s National Insurance | -£479 |
| Profit remaining before corporation tax | £36,951 |
| Less: corporation tax at 19% | -£7,021 |
| Profit after tax available for dividend | £29,930 |
| Less: dividend tax at 8.75% after allowances | -£2,575 |
| Net dividend received | £27,355 |
| Total net cash to director (salary £12,570 + dividend £27,355) | £39,925 |
Behind these numbers sit three straightforward bookkeeping entries the company would post over the year.
| Account | Dr | Cr |
|---|---|---|
| Directors’ remuneration (P&L) | £12,570 | |
| Employer’s National Insurance (P&L) | £479 | |
| Net pay payable to director | £12,570 | |
| HMRC – employer NIC payable | £479 |
Payroll entry recognising the director’s salary set at the personal allowance and the related employer NIC liability.
| Account | Dr | Cr |
|---|---|---|
| Corporation tax expense (P&L) | £7,021 | |
| Corporation tax payable (HMRC) | £7,021 |
Corporation tax charge on the £36,951 of profit remaining after deducting salary and employer NIC.
| Account | Dr | Cr |
|---|---|---|
| Retained earnings (dividends declared) | £29,930 | |
| Dividends payable to shareholder | £29,930 |
Dividend declared from distributable post-tax profit once the director’s minute and dividend voucher are prepared.
A salary set at exactly £12,570 has a second benefit beyond tax: it sits above the Lower Earnings Limit of £6,396, which means the director still builds a qualifying year towards the State Pension and other contributory benefits, even though little or no Income Tax or employee National Insurance is actually paid.
These figures are illustrative and depend on your own circumstances. If your company’s profits exceed £50,000, marginal relief tapers the corporation tax rate up to 25% at £250,000, which changes the dividend-side numbers. Directors who hold shares in other, associated companies will find these thresholds divided proportionately among those companies. Dividends can only be paid from distributable reserves, so if the company has accumulated losses or insufficient retained profit, declaring one anyway can create an illegal dividend and personal liability for the director. If you extract funds through a director’s loan account instead of salary or a properly declared dividend, any balance still outstanding nine months and one day after the company’s year end can trigger a 33.75% section 455 tax charge on the company. Always check current HMRC rates and your own company’s reserves before acting, and take advice from a qualified accountant.
What this means for your business
For most owner-managed companies with a single director-shareholder, the pattern in the worked example holds: a modest salary up to the personal allowance, topped up with dividends, extracts profit more efficiently than a salary-only approach. But the right split can shift if you are saving into a pension, since employer pension contributions are a deductible company expense and are not treated as a benefit in kind, making increased pension contributions an even more efficient use of profit in some years. It can also shift if you are applying for a mortgage, since some lenders prefer to see a consistent salary and a track record of dividends rather than retained profit sitting inside the company. And it shifts again as your company’s profits move through the corporation tax marginal relief band between £50,000 and £250,000. Review the split every year, not just once when the company is formed, because the personal allowance, National Insurance thresholds and dividend tax rates all move over time.
Key takeaways
- Set salary at or near the personal allowance, £12,570 for 2024/25, so you preserve a State Pension qualifying year while paying little or no Income Tax or employee National Insurance.
- Draw the remainder of profit as dividends only after checking the company has enough distributable reserves and has already accounted for corporation tax on that profit.
- Recalculate the split every tax year: allowances, National Insurance thresholds, dividend tax rates and the corporation tax marginal relief bands all move, so last year’s optimal split may not be this year’s.
- Keep extraction decisions separate from personal cash-flow needs; if you need more cash than a tax-efficient split provides, use a properly documented director’s loan rather than an ad hoc dividend, and repay it within nine months and one day of the year end to avoid the section 455 charge.
Want a second opinion on your extraction strategy?
Our team can model salary, dividend and pension combinations against your company’s actual numbers and current HMRC rates, so you keep more of what your business earns.
