Navigating the Dividend vs Salary Dilemma in a Changing Tax Landscape
- Brian Pusser
- Apr 18
- 3 min read
Updated: May 19
Published 18 April 2026
The recent 2% increase in dividend tax rates has shifted the balance between taking income as dividends versus a traditional salary. With the basic rate now at 10.75% and the higher rate at 35.75%, business owners face a narrower gap in tax efficiency between these two methods of profit extraction. This change, combined with the frozen £500 dividend allowance and the avoidance of National Insurance (NI) on dividends, means owners must rethink their approach, especially those nearing the higher-rate tax threshold of £50,270.
This post explores the key factors influencing the dividend versus salary decision, practical examples, and strategies to help business owners make informed choices in this evolving tax environment.
Understanding the Dividend Tax Changes
The government increased dividend tax rates by 2%, affecting both basic and higher-rate taxpayers. Here’s how the new rates compare:
Basic rate taxpayers: 10.75% (up from 8.75%)
Higher rate taxpayers: 35.75% (up from 33.75%)
Additional rate taxpayers: 39.35% (unchanged)
The £500 dividend allowance remains unchanged, meaning the first £500 of dividend income is tax-free. However, with the allowance frozen since 2018, inflation has eroded its real value.
Why This Matters
Dividends have traditionally been attractive because they avoid National Insurance contributions, which apply to salaries. But the tax hike reduces the dividend advantage, especially for those close to or above the higher-rate threshold.
Comparing Dividends and Salary: Key Considerations
When deciding between dividends and salary, business owners should weigh several factors:
1. Tax Rates and Thresholds
Salary is subject to income tax and National Insurance contributions (both employer and employee).
Dividends are taxed at the dividend tax rates but avoid National Insurance.
For example, a salary of £50,000 attracts income tax and NI, while dividends of the same amount face dividend tax but no NI.
2. National Insurance Contributions
Salaries incur:
Employee NI at 12% on earnings between £12,570 and £50,270
Employer NI at 13.8% on earnings above £9,100
Dividends incur no NI, making them attractive for reducing overall tax bills.
3. Pension Contributions and Benefits
Salary payments count as earnings for pension contributions and certain state benefits. Dividends do not, which can affect long-term retirement planning and eligibility for benefits.
4. Cash Flow and Business Profits
Salaries are deductible expenses for the company, reducing corporation tax liability. Dividends are paid from post-tax profits, so the company must have sufficient retained earnings.
Practical Examples of Income Extraction
Example 1: Basic Rate Taxpayer
Salary: £40,000
Dividends: £10,000
Tax on salary:
Income tax on £27,430 (£40,000 - £12,570 personal allowance) at 20% = £5,486
Employee NI on £27,430 at 12% = £3,291.60
Employer NI on £30,900 (£40,000 - £9,100) at 13.8% = £4,264.20
Tax on dividends:
£10,000 dividends minus £500 allowance = £9,500 taxed at 10.75% = £1,021.25
Total tax and NI:
Salary + employer NI = £5,486 + £3,291.60 + £4,264.20 = £13,041.80
Dividends = £1,021.25
Example 2: Approaching Higher-Rate Threshold
Salary: £45,000
Dividends: £15,000
At this level, some dividends fall into the higher-rate tax band, increasing the tax burden on dividends.
Strategies to Balance Dividends and Salary
Adjust Salary to Stay Below Higher-Rate Threshold
Business owners can set salaries just below the £50,270 threshold to minimize higher-rate tax exposure. This allows dividends to be taxed at the basic rate.
Use Dividends to Supplement Income
After paying a salary that covers personal allowance and NI thresholds, dividends can supplement income efficiently, especially if the total income remains within the basic rate band.
Consider Employer National Insurance Savings
Reducing salary and increasing dividends can save employer NI, but this must be balanced against pension contributions and benefit entitlements.
Plan for Pension Contributions
Since dividends do not count as pensionable earnings, consider making additional pension contributions if relying heavily on dividends.
When Salary Might Be More Advantageous
If the business owner requires state benefits or higher pension entitlements, a higher salary may be preferable.
For those with family members involved in the business, paying salaries to them can utilize personal allowances and reduce overall tax.
If the company has limited retained earnings, paying a salary ensures regular income without relying on dividends.
Recalculating Your Extraction Strategy
Given the tax changes, business owners should:
Review current income extraction methods.
Calculate tax liabilities under different salary and dividend mixes.
Consider personal circumstances such as pension goals and benefit needs.
Consult with a tax advisor to tailor strategies.
The increase in dividend tax rates narrows the advantage dividends once held over salaries. While dividends still avoid National Insurance, the higher tax rates and frozen dividend allowance mean business owners must carefully plan how to extract profits. Balancing salary and dividends based on individual circumstances and tax thresholds can optimize take-home pay and long-term financial health.
