A director of a small design company pays herself £2,000 a month because that is what the mortgage and the nursery cost. Some months the company bills £14,000. Some months it bills £3,000. She has never distinguished between the two kinds of payment her accountant makes, and at the year end she is told that £9,400 of what she took last year was not covered by profit and is now a loan she owes the company.
The salary and dividend question is usually presented as an optimisation problem. It is mostly a discipline problem wearing an optimisation problem's clothes.
The two routes are taxed on completely different machinery
A salary is employment income. It is a deductible expense for the company, so it reduces Corporation Tax. It attracts income tax through PAYE, employee National Insurance, and employer National Insurance, which the company pays on top of the salary.
A dividend is a distribution of profit after Corporation Tax. It is not a company expense and does not reduce Corporation Tax. It carries no National Insurance at all, and it is taxed at dividend rates, which are lower than the equivalent income tax rates.
That asymmetry is the whole of the argument. A dividend avoids two lots of National Insurance but has already been through Corporation Tax. A salary escapes Corporation Tax but pays National Insurance twice.
The numbers as they stood in 2025/26 give the shape. The personal allowance was £12,570. Dividend rates were 8.75% for basic rate taxpayers, 33.75% for higher rate and 39.35% for additional rate, with a dividend allowance of £500, down from £2,000 two years earlier. Employer National Insurance was 15% above a secondary threshold of £5,000 from 6 April 2025, having previously been 13.8% above £9,100. Corporation Tax was 19% on profits up to £50,000 and 25% above £250,000, with marginal relief in between.
All of those move. Dividend rates in particular have been altered repeatedly since 2016 and further increases have been announced. Treat any specific figure as a snapshot with a date on it, and check the current year before you set a pattern for twelve months.
The usual answer is a small salary and the rest as dividends
The common structure is a salary set at a level that preserves your National Insurance record without generating much of a bill, then dividends on top.
The reason for taking any salary at all is not tax efficiency in the narrow sense. It is that a qualifying year for the State Pension requires earnings at or above the Lower Earnings Limit, and dividends do not count towards it. Take nothing as salary and you accrue nothing towards your pension or towards contribution-based benefits, which is an expensive way to save a modest amount of National Insurance.
Where exactly to set the salary depends on whether the company can claim the Employment Allowance, which reduces an employer's National Insurance bill by a set amount each year. A company whose only employee is a single director who is also its only director generally cannot claim it. A company with a second employee on the payroll usually can, which sometimes makes a higher salary the better answer. That single distinction is why two accountants give two different recommendations to two apparently identical companies.
There is one more factor that has nothing to do with tax. Lenders assess affordability on income they can evidence. A director on a £9,000 salary and £45,000 of dividends is a harder mortgage application than a salaried employee on £54,000, even though the economics are similar. Some lenders will take two years of dividends, some will not, and some will look at retained profit. If you are buying a house in the next two years, say so before you optimise.
At some point the split stops earning its keep
The saving from picking the right split is real and finite. For a typical small company owner drawing somewhere in the range of £40,000 to £60,000, the difference between a sensible structure and a naive one is usually a few hundred pounds to a low four-figure sum a year. It is worth doing once and then leaving alone.
Above that, three things start to dominate and they are all larger than the salary and dividend question.
- Pension contributions made by the company. Employer contributions are generally deductible for Corporation Tax, carry no National Insurance, and are not taxed as income when made. For a higher rate taxpayer this is usually the single biggest lever available, subject to the annual allowance and its taper.
- Whether you need the money at all. Profit left in the company has paid Corporation Tax and nothing else. Drawing money you do not spend, purely out of habit, is paying dividend tax years earlier than you needed to.
- Marginal relief between £50,000 and £250,000 of profit, which produces an effective marginal Corporation Tax rate higher than 25% across that band and makes the timing of expenditure worth thinking about.
There is also the interaction with the High Income Child Benefit Charge and with the tapering of the personal allowance above £100,000. Both create bands where an extra pound of income is taxed far above the headline rate. A director who can choose when to take a dividend can choose which tax year it falls into, which is a bigger lever than the choice of route.
A dividend requires profit to exist on the day you declare it
Part 23 of the Companies Act 2006 permits a distribution only out of profits available for the purpose, meaning accumulated realised profits less accumulated realised losses. This is not a formality and it is not tested at the year end. It is tested at the moment of the distribution, by reference to relevant accounts.
If the profits were not there, the dividend was unlawful. It can be required to be repaid, and a director who knew or ought to have known the position is on difficult ground. What usually happens in practice is that the accountant reclassifies the payments as a director's loan.
An overdrawn director's loan account has consequences of its own. If it is still outstanding nine months and one day after the end of the accounting period, the company pays a tax charge on the balance under section 455, refundable only when the loan is repaid. A loan over £10,000 is a benefit in kind unless interest at the official rate is charged, which means a P11D and Class 1A National Insurance. And in an insolvency, the loan is simply a debt you owe the company, collectable by the liquidator.
The fix is unglamorous. Decide dividends deliberately, at a point in the month, against management accounts that are up to date, with a board minute and a dividend voucher for each one. Run a standing order for a modest salary and treat dividends as separate events rather than as topping up your bank account. If your personal outgoings need £2,000 a month and the company can only support £1,400, that is information about the business, not a problem to be solved by the payroll.
Where this shows up in the game
Business Baron makes you take money out of the company deliberately, and it does not stop you taking money that is not there. Draw against profits you have not made and the loan account builds quietly until the year end, at which point the tax charge and the conversation with your accountant both arrive. Because the game carries dated tax rules from 1930 onward, the right answer changes across a career as rates move under you. You can learn the expensive version of this lesson in the free game, for nothing.