How to Structure Dividends and Salaries for Limited Company Tax Savings

Running your own limited company in the UK offers you more flexibility and control than being self-employed. But with that flexibility comes responsibility particularly when it comes to deciding how you pay yourself.

The way you structure your salary and dividend payments can have a major impact on your personal income, business cash flow, and overall limited company tax savings. Understanding the rules, rates, and thresholds is crucial if you want to minimise your tax bill while staying fully compliant with HMRC.

In this post, we’ll break down the key principles of salary vs dividends, the tax implications of each, and how you can strike the right balance to achieve maximum efficiency.

What Are Salaries and Dividends?

Salary

A salary is payment made to you as an employee of your company, usually through the PAYE (Pay As You Earn) system. This means:

• Income Tax is deducted at source.
• National Insurance Contributions (NICs) are paid by both employer (the company) and employee (you).
• Salaries count as an allowable business expense, reducing your Corporation Tax bill.

Dividends

A dividend is a share of company profits distributed to shareholders. Dividends can only be paid if the company has retained profit after Corporation Tax. They:

• Do not reduce Corporation Tax (as they are paid from post-tax profits).
• Are taxed at separate, usually lower, dividend tax rates.
• Do not attract National Insurance Contributions.

The Key Tax Differences Between Salaries and Dividends

Why Mix Salary and Dividends in a Limited Company?

• Tax efficiency: A small salary ensures access to personal allowances and reduces Corporation Tax, while dividends avoid NICs.
• Pension eligibility: To make pension contributions, you need qualifying income salary covers this, dividends don’t.
• State benefits: Certain benefits (maternity pay, state pension credits) require a minimum salary.
• Flexibility: Dividends can be paid irregularly, matching cash flow.

In practice, most directors pay themselves a low salary + dividends combination.

How to Structure Salary for Tax Efficiency

Official Class 1 National Insurance Thresholds (2025–26)

• Lower Earnings Limit (LEL): £6,500 per year, or £125 weekly / £542 monthly
• Primary Threshold (PT): £12,570 per year, or £242 weekly / £1,048 monthly
• Secondary Threshold (ST): £5,000 per year, or £96 weekly / £417 monthly

What This Means for Single-Director Companies

Common Salary Strategies

£5,000 Salary

• Employer NICs: No employer National Insurance because it’s at or below the Secondary Threshold.
• Employee NICs / Income Tax: Also avoids employee NIC and income tax obligations.

£6,500 Salary

• Employee: Reaches the Lower Earnings Limit, earning National Insurance credits toward State Pension and benefits, but still doesn’t trigger NIC deductions.
• Employer: Still below the Secondary Threshold, so no employer NIC.
• Benefit: Useful if you want to maintain contribution records without paying NICs.

£12,570 Salary

• Employee: Reaches the Primary Threshold, so employee starts paying NIC (8%) on earnings above this level. Income tax is also due above personal allowance.
• Employer: Still below the Secondary Threshold, so no employer NIC.
• Benefit: Maximizes corporation tax deduction for salary but increases NIC and income tax costs.

Recommendation (“Sweet Spot”)

For most single-director companies in 2025/26, the optimal salary structure tends to be:

• A salary set at around £6,500 this ensures you build NI credits without incurring employee or employer NICs.
• It avoids employer NIC yet maintains your qualifying NI years, and still provides some corporation tax reduction.
• If greater corporation tax relief is the priority and you can tolerate paying employee NIC and some income tax, then £12,570 is the upper limit before employer NIC applies but it’s more expensive on take-home pay.

Let me know if you’d like a refined table comparing actual NIC and income tax costs across those salary levels or a full breakdown of the impact on dividends and corporation tax!

How to Structure Dividends for Tax Efficiency

2025/26 Dividend Allowances and Rates

• Tax-free Dividend Allowance: £500
• Basic Rate:75% (on dividend income falling within the basic rate band: total taxable income £12,571 – £50,270)
• Higher Rate:75% (on dividend income within £50,271 – £125,140)
• Additional Rate:35% (on dividend income above £125,140)

Practical Steps

• Pay dividends only from post-tax profits (after Corporation Tax, which is 19%–25% depending on profit levels).
• Keep it formal: Prepare board minutes and issue dividend vouchers both are legal requirements.
• Plan timing carefully: Spread dividends across tax years to maximise use of allowances and avoid pushing yourself into higher tax bands unnecessarily.
• Mix with salary efficiently: The balance between salary and dividends should be reviewed annually against thresholds for NIC, personal allowance, and dividend tax bands.

Tip: For most single-director limited companies in 2025/26, combining a £6,500 salary with dividends up to the basic rate threshold (£50,270 total taxable income) offers a highly tax-efficient strategy.

Pension Contributions and Other Allowances

• Company pension contributions – Payments made by your limited company into your pension are treated as an allowable business expense. This reduces your Corporation Tax liability and is usually more tax-efficient than taking the same money as dividends.
• No NICs – Unlike salaries, employer pension contributions don’t attract employee or employer National Insurance Contributions (NICs).
• Trivial benefits – You can provide small, tax-free perks worth up to £50 per benefit, capped at £300 per director per year. These can’t be cash or cash vouchers, but things like gift cards, flowers, or a meal out qualify.
• Annual Investment Allowance (AIA) – Businesses can claim 100% relief on qualifying plant and machinery purchases (up to £1 million per year). Using AIA and other deductions reduces your taxable profits before dividends are considered.
• Other allowances – Don’t overlook reliefs such as R&D tax credits, business mileage allowances, or home office expenses — all of which can reduce taxable profits and improve overall efficiency.

Pitfalls and Common Mistakes to Avoid

Even with the best intentions, many directors fall into traps when structuring their pay. These mistakes can cost you thousands in tax, attract HMRC scrutiny, or disrupt cash flow. Here are the most common errors  and how to avoid them:

Paying Dividends Without Sufficient Profit

• Rule: Dividends can only be paid out of retained profits (profits after Corporation Tax has been deducted). Paying dividends without available profit is illegal and classed as an “unlawful dividend.”
• Risk: Directors may be forced to repay unlawful dividends, and if the company later becomes insolvent, personal liability and penalties can arise.
• Tip: Always prepare management accounts before declaring dividends to confirm sufficient distributable reserves exist.
• Resource: HMRC Dividend Rules

Ignoring NIC Thresholds

• Rule: A well-structured salary ensures you hit the Lower Earnings Limit (LEL), which gives you NI credits for State Pension, without triggering unnecessary NIC costs.
• Risk:
  • Paying too little salary (below £6,500 in 2025/26) means you miss out on NI credits for State Pension.
  • Paying too much salary increases NIC liabilities unnecessarily.
• Tip: For most single-director companies in 2025/26, a salary of around £6,500 per year is often optimal — you get NI credits and Corporation Tax relief, without paying employee or employer NIC.
• Resource: NI thresholds and rates

Mixing Personal and Company Funds

• Rule: A limited company is a separate legal entity. Using the company bank account for personal spending risks HMRC treating it as a director’s loan.
• Risk: Outstanding director’s loans can trigger extra Corporation Tax under Section 455 CTA 2010 (currently at 33.75%) if not repaid within 9 months of year end. It also creates messy records and risks compliance issues.
• Tip: Always pay yourself via PAYE salary or dividends. Keep a dedicated business bank account. Tools like Starling Business, Tide, or Monzo Business make this simple.
• Resource: HMRC Director’s Loan Account guidance

Forgetting Payments on Account (Self-Assessment)

• Rule: If your dividend income pushes your total tax bill over £1,000 (after tax deducted at source), HMRC may require payments on account towards the next year’s bill.
• Risk: A surprise second payment in January (and again in July) can cause cash flow strain.
• Tip: Use accounting software (like Xero, FreeAgent, or The Balance App) to set aside 20–30% of dividends in a separate tax savings account.
• Resource: HMRC Payments on Account

Assuming One Size Fits All

• Rule: What’s optimal depends on your full financial situation — other income, benefits, or whether you have a spouse shareholder.
• Risk: Copying a “standard setup” from the internet may cause you to overpay tax or miss out on allowances.
• Tip: Tailor your approach. For example:
  • A spouse shareholder can double the £500 dividend allowance.
  • Pension contributions are often more efficient than dividends for higher earners.
  • Timing dividends across tax years can keep you in a lower band.
• Resource: HMRC Tax Rates and Allowances

Takeaway: Most pitfalls come from poor planning and record-keeping. A proactive accountant can help you design a structure that keeps you compliant while maximising your limited company tax efficiency.