Dividends vs salary – why getting it wrong can hurt

At a glance

• Dividend tax rates are rising and thresholds are frozen, so the old dividend first approach is no longer always the most tax efficient choice.
• The right mix of salary and dividends affects more than tax.  – It shapes pension build up, access to benefits, borrowing power and cashflow stability.
• Many directors may now benefit from taking a higher salary to protect long-term entitlements and support financial plans.

Now that the self-assessment deadline has passed, many directors are taking the opportunity to review how they extract profits from their companies.

At Elephant’s Child, we often get asked: What’s the most tax-efficient way to pay myself? There are a number of ways owners can remunerate themselves, typically through salary, dividends, or a combination of the two. The answer has often leaned heavily toward dividends. However, recent changes have made the picture less clear. With dividend tax rates rising, thresholds frozen, and additional reporting requirements on the horizon, the decision is no longer as straightforward.

The decision between salary and dividends is not only about this year’s tax. It also affects your pension, state benefits, borrowing power and long-term financial security. Getting the balance wrong can be expensive.

Understanding the difference

A salary is treated as earned income. It is subject to income tax and national insurance, but it also counts towards state benefits and helps build qualifying years for the state pension. It provides a consistent, predictable income stream. This is favoured by lenders  when assessing mortgage or loan applications.

Dividends, by contrast, are paid from profits after corporation tax. They are generally taxed at lower rates than salary and do not attract national insurance. Historically, this has made them attractive. However, they do not count towards pension accrual or most state benefits. They can also appear less stable from a lender’s perspective.

For many directors, the optimal approach has historically been a blend: sufficient salary to protect long-term entitlements and preserve allowances, with dividends used to maintain overall tax efficiency. Increasingly that balance requires more careful review.

The impact of recent and upcoming changes

Measures announced in the 2025 Autumn Budget are set to influence how directors structure their income in the coming years.

The dividend allowance remains at £500. But from April of this year dividend tax rates will rise to 10.75%, 35.75%  and 39.35% for basic, higher rate and 
additional rate taxpayers respectively.

Dividends taken within ISAs, LISAs and pensions remain tax-free. However, the widening tax burden outside of these wrappers reduces their historic advantage.

From April 2027, savings and property income tax rates will rise by two percentage points. , Existing allowances remain unchanged. Income tax thresholds are frozen until 2031. meaning more people will move into higher tax bands over time – a process known as fiscal drag.

Taken together, these changes narrow the gap between salary and dividend tax efficiency, particularly for higher earners.

When salary may be the better option

There are circumstances where increasing your salary makes strategic sense.

For example, a higher-earning director taking the majority of income as dividends at around £120,000 may find that increasing their salary to £50,000 spreads income more evenly across tax bands. It also strengthens pension contribution capacity and supports entitlement to certain benefits.

Similarly, a mid-earning director drawing £50,000 in dividends may benefit from introducing or increasing salary to remain within lower tax thresholds while maintaining eligibility for statutory benefits.

Beyond tax, salary offers practical advantages. It  facilitates regular pension contributions and supports mortgage applications. It provides predictable cashflow, and reduces reliance on fluctuating company profits.

What to consider?

Tax efficiency should never be considered in isolation. The way you remunerate yourself affects:

• Long-term pension provision
• Access to state benefits
• Mortgage and borrowing capacity
• Cashflow stability
• Exposure to future tax changes

With dividend tax rates rising and thresholds frozen, many directors would benefit from revisiting their salary/dividend mix now rather than defaulting to historic patterns.

Thinking about selling your business?

If you are thinking about selling your business in the coming years, don’t worry too much about the impact of salary v dividends on that process. Work out what is best for you during the time that you own and run the business. As part of the sale preparations, a process can be conducted to normalise the profits in a way that reflects how the business will be run by the acquirer.

For you as an individual, reviewing your strategy now, rather than during the next self-assessment rush, allows for proactive planning rather than reactive adjustments.

A relatively small change to your approach can improve overall tax positioning, strengthen your pension outlook, and better support major life goals such as property purchases or retirement planning.

St. James’s Place (SJP) work in conjunction with an extensive network of external growth advisers and SME specialists, such as Elephants Child, who have been carefully selected by SJP. The services provided by these specialists are separate and distinct from those carried out by St. James’s Place and include advice on how to grow your business and prepare your business for sale and exit.

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’sPlace.

The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.

SJP Approved 20/02/2026