What’s the Difference Between Director Salary and Dividends?
If you run a limited company, one of the first financial decisions you’ll face is how to pay yourself. Two common methods are salary and dividends, but they work very differently in terms of tax, timing, and how they impact both you and the company.
Understanding the distinction between the two helps you make informed decisions about managing your income efficiently.
Director Salary – How It Works
A salary is regular pay that goes through the company’s payroll (PAYE) system. It’s just like how employees are paid — with deductions for Income Tax and National Insurance.
Key Features:
Processed through PAYE.
Subject to Income Tax and National Insurance (both employee and employer contributions).
Counts as an allowable business expense — it reduces the company’s taxable profits.
Provides entitlement to the state pension and other benefits.
Considered “earned income” for things like mortgage applications.
When Is Salary Useful?
If you want regular, stable income.
To maintain state pension contributions.
If you want to reduce Corporation Tax (since salaries are tax-deductible).
If you are applying for personal finance like mortgages, where lenders often prefer salaried income.
Dividends – How They Work
Dividends are payments made to shareholders from the company’s post-tax profits. This means the company must have already paid Corporation Tax before declaring dividends.
Key Features:
Paid from retained profits after tax.
Not subject to National Insurance.
Taxed at lower rates compared to salary.
Only payable if the company has sufficient profits (they cannot be paid from losses).
Irregular — you choose when to issue dividends rather than receiving them like a fixed salary.
When Are Dividends Useful?
To reduce personal tax liability (compared to taking high salaries).
When the company has profits available.
When you want flexible income that isn’t tied to a payroll schedule.
The Tax Differences
Salary:
Subject to Income Tax after your personal allowance (currently £12,570 for 2024/25).
Employee National Insurance applies above the threshold.
Employer’s National Insurance also applies, which the company must pay.
Reduces Corporation Tax, because salary is a business expense.
Dividends:
Paid after Corporation Tax.
Not a business expense (doesn’t reduce Corporation Tax).
No National Insurance.
Dividend tax rates are lower than Income Tax rates:
£500 tax-free dividend allowance.
8.75% (basic rate)
33.75% (higher rate)
39.35% (additional rate)
Practical Example
Imagine your company earns £50,000 in profits.
If You Take Salary:
Pay yourself £50,000 through PAYE.
Income Tax and National Insurance apply.
The company’s Corporation Tax reduces because salary counts as an expense.
If You Take Dividends:
The company first pays Corporation Tax on £50,000.
You then take the remaining profit as dividends.
Dividends are taxed at dividend rates, with no National Insurance.
The Combined Approach:
Many directors use both:
A small salary, often around £12,570 (the personal allowance).
The rest as dividends — which keeps taxes lower overall while still benefiting from state pension contributions.
Benefits of Salary
Builds National Insurance record (for state pension and other benefits).
Regular, predictable income.
Reduces company Corporation Tax.
Favoured by mortgage lenders.
Drawbacks of Salary
Employee and employer National Insurance applies.
Higher tax rates compared to dividends at higher income levels.
Benefits of Dividends
No National Insurance.
Lower tax rates.
Flexible — paid when profits allow.
Drawbacks of Dividends
Must have enough retained profit to pay them legally.
Doesn’t reduce Corporation Tax.
No National Insurance contributions — doesn’t contribute to your state pension.
Some lenders don’t favour dividend income as much as salary.
Rules and Compliance
Salaries require payroll registration, regular tax filings, and payments to HMRC through PAYE.
Dividends require formal declaration — board meeting minutes and dividend vouchers are necessary, even if you’re the sole director/shareholder.
Which Is Better?
Neither is strictly better — it depends on:
Your income needs.
How profitable your company is.
Whether you need stable income for things like mortgages.
Whether you want to prioritise tax efficiency over simplicity.
Summary
In simple terms:
Salary is fixed, predictable, taxed more heavily, but reduces Corporation Tax and builds your National Insurance record.
Dividends are flexible, taxed more favourably, but depend on profits and don’t reduce Corporation Tax.
Most directors use a blend — a small salary combined with dividends — to balance tax savings with practical needs like pension contributions and financial stability.
