Salary or Dividend: Which is the best way for your business to pay you? The answer depends on a number of factors: how much profit your company has or is expected to make, your existing income, the current rates of tax and National Insurance and whether you’re taking advantage of currently available allowances.

Background

Its true that as we settle into the new tax year, many company directors will be reviewing their remuneration strategies. With several significant tax changes coming into play, it could be worth reconsidering your approach for 2025-26.

·      Salary: Pros and Cons - Taking a salary means it's taxed through PAYE, with income tax and National Insurance deducted at source. This can boost your pension contributions and improve personal borrowing power for things like a mortgage, but it may also push you into a higher tax band.

·      Dividend: Pros and Cons – basically dividends aren’t subject to National Insurance and are often a more tax-efficient way of taking money out of a company. However, they can only be paid from company profits after corporation tax. Also, the tax-free dividend allowance has now been reduced to £500, so more of the dividend is now taxable than in the past.

·      So, which is better? - It depends. Sometimes it makes sense to mix both to strike the right balance between tax efficiency and personal financial goals. What works best for one director/shareholder might not be right for another.

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What is changing?

Let’s look at some of the important changes which may impact how directors can pay themselves.

·      For shareholders in owner-managed businesses, from the 2025-26 tax year, new dividend disclosure rules will come into force. If you are a director holding shares in a company, you will need to use the employment pages of your self-assessment tax return to report dividend income received from your own companies, and the percentage shareholding held in those companies.

·      From April 2025, self-employed individuals must declare when any self-employment commenced or ceased. While the exact reporting mechanism is not yet clear, it is likely to be via the self-employment pages of your self-assessment tax return.

This additional reporting gives HMRC more information to target individuals who they believe might actually be employees. The length of self-employment can impact your status in HMRC’s view, potentially leading to questions about your tax position so it’s worth seeking advice on your situation.

Perhaps the most significant changes involve employers’ National Insurance (NI) contributions. Key things to note are that the threshold has reduced from £9,100 to £5,000, and the rate has increased to 15%. This means employers will pay Class 1 NI at a higher rate and will start paying it earlier than in previous years. On the positive side, the employment allowance has increased from £5,000 to £10,500, and the eligibility threshold that restricted it to smaller employers has been removed.

However, to claim this allowance, you must have at least two directors/employees on a salary over £5,000. Single directors with no other employees on payroll cannot claim it. Furthermore, if you have multiple connected companies and payrolls, the allowance can only be claimed once against one payroll – an important consideration for those with group companies.

How to make the right decision

Ultimately, choosing the right option depends on your personal and business goals. Both remuneration options would qualify for state pensions under the National Insurance rules and both allow you to get a mortgage, although a salary might make things very slightly easier. Salaries are also better for business budgeting and planning purposes as it allows you to build in a consistent figure when it comes to cashflow.

Dividends may allow you to maximise your take-home pay, as long as you have sufficient profits to support the dividend payments. And you may prefer to minimise National Insurance payments. It also helps if you can personally deal with less monthly variations in income. Many directors find that a carefully balanced combination of salary and dividend offers the best of both worlds, providing some regular income while maximising overall returns and maintaining flexibility in how profits are extracted.

Four tips to help you plan ahead

Regardless of the route you decide to take, with the changes to employer NI and reporting requirements, planning becomes even more important. To ensure your position is optimised you need to consider and put in place the following:

1. Forecast your company’s profits for the year and replace forecast figures with actual one’s as they occur. This way your forecast will become more accurate, and you can make more considered decisions about what to do.
2. Calculate your optimal salary level based on NI thresholds and remodel this as profits become clearer
3. Put in place a dividend strategy that balances personal income needs with business investment requirements. Make sure personal gain doesn’t impinge on business opportunities.
4. Review your approach quarterly as the whole situation becomes clearer and the outcomes easier to measure.

Remember that taking dividends when there are not sufficient profits can create problems, for example these may be classed as a director’s loan and will need to be repaid or taxed accordingly.

As with most financial decisions, there is no one-size-fits-all answer. The best approach depends on your specific circumstances, goals and the financial health of you and your business.  If you’re thinking about dividends or salary, or a mixture approach we can help you work out the most tax-efficient way to do it, based on your company’s situation and your personal plans. For a personalised strategy, it is always worth talking with us, we can give you the advice that is right for you.

At Kaizen we have a lot of experience in helping clients with their personal remuneration strategies, please do not hesitate to call us on 01482 772261 or email us at info@kaizengroup.uk if you want to book a meeting and learn more about how we can help you get the maximum personal return from your business.  

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