Should I take dividends or salary, or both?
Most business owners want to take income in a smarter, more tax-efficient way. The challenge is working out the right balance between salary and dividends, understanding what’s allowed in law, and making sure the company can actually afford what you take.
A good structure gives you consistent take-home pay now and a stronger foundation for long-term financial freedom. A poor structure can leave the business short of cash or push you into taking illegal dividends. So getting this right matters.
How salary works for directors
A director’s salary is treated as employment income. It’s processed through PAYE once it reaches HMRC’s tax or National Insurance thresholds. If the company doesn’t already have a PAYE scheme, it must register when those thresholds are met.
A salary is an allowable business expense, so the company gets Corporation Tax relief on it. Even a small, well-planned salary can be useful because:
it counts as qualifying earnings for state pension and state benefits;
it creates a base level of consistent income; and
it can support mortgage applications.
Find out more about HMRC guidance on PAYE registration and director income.
How dividends work for directors
Dividends can only be paid from distributable profits. This usually means retained profits after Corporation Tax. It’s a legal requirement under the Companies Act 2006. If the company doesn’t have enough profit on the balance sheet, the dividend is illegal, even if you have plenty of cash in the bank.
You can read more about the Companies Act 2006 rules on distributions here.
Dividends attract no National Insurance and are taxed at dividend tax rates, which are usually lower than income tax. They must be supported by:
a board meeting or written resolution;
a proper dividend voucher; and
up-to-date accounts that prove the company has available profit.
Follow this link for HMRC’s guidance on dividend paperwork.
The advantages of mixing salary and dividends
For most owner-managed limited companies, a combination of the two is the most efficient structure. A common approach is:
A small salary at or above the Lower Earnings Limit
Dividends drawn from retained profits when affordable
This usually results in lower overall tax while keeping you eligible for state pension credits and other benefits. Dividends do not reduce Corporation Tax but avoiding higher National Insurance costs often produces a better overall outcome.
Why affordability matters
A dividend is legal only if the company has profit available for distribution. It must be checked using real numbers, not bank balance alone.
Two affordability rules are essential:
1. The business must have available profit
This is a compliance point. If you take dividends without available profit, they can be reclassified as directors’ loans or illegal distributions, which can trigger higher tax, repayment demands and interest charges.
2. The business must have enough cash
Even with a profit on paper, the company must be able to afford the payment after meeting VAT, PAYE, supplier invoices and future commitments. Overdrawing is one of the main reasons small businesses run into cash-flow pressure.
This is why real-time data matters. Regular management accounts show you exactly where you stand and reduce the risk of taking drawings the company can’t support.
Practical guidance for getting the balance right
Keep your salary at a strategic level: Many owners choose a salary that secures state pension contributions while keeping National Insurance costs down. The exact level depends on whether the company is claiming Employment Allowance.
Plan dividends based on live numbers: Use management accounts that are sufficiently reliable to support a distribution before declaring dividends. Always record the paperwork correctly.
Build personal wealth, not just business profit: Retained profit is important, but so is extracting and investing it in ways like building your pension or putting more into ISAs.
Avoid large, reactive withdrawals: A single large dividend late in the year can trigger higher-rate tax and sudden cash pressure. Smaller, planned dividends often work better.
Watch your Directors’ Loan Account: Overdrawn loan accounts can quickly become a problem if not monitored. Regular reviews stop this from becoming a surprise tax bill.
Get advice on choosing the right mix for your income
A balanced mix of salary and dividends gives you control. It keeps your income steady, supports tax efficiency and protects the company’s cash so it can keep growing. When your drawings are planned around real numbers, you avoid surprises, build personal wealth with intention and give yourself a stronger pathway towards long-term financial freedom.
Get in touch for clarity on how to structure your salary and dividends.