A question we’re hearing more frequently as new tax changes take effect is whether directors should move away from the traditional salary-plus-dividends model and take all income as PAYE salary instead.
It’s a fair question.
What’s changing?
From April 2026, dividend tax rates will increase by 2 percentage points for basic and higher rate taxpayers. Naturally, this has prompted many business owners to reconsider how they extract profits. But does this change actually justify abandoning dividends altogether?
In the current tax year, dividend tax rates are rising as follows:
- Basic rate: 8.75% → 10.75%
- Higher rate: 33.75% → 35.75%
- Additional rate: unchanged at 39.35%
The £500 dividend allowance remains, and the £12,570 personal allowance still applies to salary.
So, yes, dividends are becoming slightly less efficient – but that’s only part of the picture.
Salary plus dividends: Does this strategy still work?
For a single director with £100,000 of company profit, the numbers remain clear.
A low salary combined with dividends still results in a lower overall tax burden than taking the full amount as PAYE salary. The difference is meaningful – around £3,800 more take-home income using the mixed approach.
This is because…
- Salary is subject to income tax and both employee and employer National Insurance
- Dividends are not subject to National Insurance
- Employer National Insurance (currently 15% above thresholds) creates an additional cost for the company
Importantly, single-director companies typically cannot benefit from the Employment Allowance, which further increases the cost of a full salary approach.
Even with higher dividend tax rates, avoiding National Insurance remains a significant advantage.
What about family companies?
For husband-and-wife or family-run businesses, the position is more balanced.
Where two directors each take a modest salary and split dividends, the tax difference between the two strategies becomes marginal. At £100,000 profit, the mixed approach is only around £500 more efficient annually.
This is largely because such companies can often claim the Employment Allowance, eliminating employer National Insurance on lower salaries.
But the real advantage in these structures comes from income splitting. Two individuals utilising personal allowances and lower tax bands can significantly increase overall household take-home pay.
The bigger picture: practical considerations
Tax efficiency is important, but it’s not the only factor.
A higher PAYE salary can be beneficial where:
- Mortgage applications require consistent, provable income
- Statutory maternity or paternity pay is relevant
- You prefer simplicity over optimisation
On the other hand, dividends offer:
- Flexibility in timing income
- No National Insurance exposure
- Greater control over personal tax planning
Remember that as long as your salary is above the Lower Earnings Limit (£6,500), you also qualify for State Pension credits. Also, if your company is claiming for R&D, your salary is a deductible expense but your dividends are not.
There are also compliance considerations. Dividends must be paid from retained profits and properly documented, and they must be reported via self-assessment to HMRC.
A note of caution
One area that should not be overlooked is the director’s loan account.
Taking funds outside of salary and declared dividends can create an overdrawn position. If not cleared within the required timeframe, this can trigger a 33.75% tax charge under Section 455 – an avoidable and costly mistake.
Final thoughts
While the dividend tax increase does reduce the advantage of dividends, it doesn’t eliminate it.
For most directors, a combination of modest salary and dividends remains the most tax-efficient approach.
What has changed is the margin – which means regular review is more important than ever.
Ultimately, the right strategy depends on your profit levels, business structure, and personal circumstances. A tailored approach is always better than a one-size-fits-all solution.
Want to discuss this in more detail? As tax specialists and small business accountants in Peterborough we would love to help. Get in touch today.
