Ask five directors how they pay themselves and you will get five confident answers, most of them inherited from a friend, a forum, or an accountant they left three years ago. The uncomfortable truth is that the optimal split changes as rates and thresholds change, and a structure that was efficient a few years ago may not be now.
The basic mechanics
Salary is a deductible expense for the company, so it reduces corporation tax. It also attracts income tax and both employee and employer National Insurance. Dividends are paid out of post-tax profit, so they do not reduce corporation tax, but they carry no National Insurance and are taxed at lower rates than salary in the recipient's hands.
That trade-off — National Insurance saved against corporation tax relief lost — is the whole calculation. Where it lands depends on the rates in force, your total income, and how much you actually need to take out.
What the answer actually depends on
- Your total personal income, including anything from outside the company
- Whether the company qualifies for the employment allowance against employer NI
- Whether you need a qualifying year for your state pension record
- Whether you are drawing everything out or leaving profit in the company
- Pension contributions — an employer contribution is often more efficient than either salary or dividends
- Whether you will need provable income for a mortgage application
Where directors most often go wrong
The most expensive mistake is not the salary and dividend split at all — it is taking money out of the company without deciding what it is. Drawings that are not salary and not a properly declared dividend become a director's loan, and an overdrawn loan account at year-end can trigger an additional corporation tax charge, plus a benefit-in-kind on the interest-free element.
The second is declaring dividends the company could not lawfully pay. A dividend must come from distributable profits. If the company did not have them, the dividend is unlawful and may be reclassified — typically as salary, with the tax and National Insurance that follows.
Get the paperwork right
A dividend needs a board minute and a dividend voucher, dated at the point of declaration. This is a five-minute job that is almost universally skipped, and it is the first thing looked for if the position is ever challenged.
This article is general information, not advice. Tax treatment depends on your individual circumstances and the rules change. Please take advice specific to your situation before acting on anything here.