Salary vs Dividends in 2025/26: the Optimal Split Has Changed

The standard advice for director-shareholders has been consistent for years: pay yourself a salary up to the National Insurance secondary threshold, take the rest as dividends. That advice still holds - but the threshold has changed, and the cost of getting the salary wrong is now higher than it was. From April 2025, the Employer NI threshold dropped from £9,100 to £5,000, and the rate rose from 13.8% to 15%. Both changes matter for working out the optimal split.

What changed in April 2025

Two Employer NI changes took effect from 6 April 2025:

For most sole director companies without employees, the Employment Allowance is not available; it was restricted to companies with more than one director on the payroll, or companies with at least one other employee, from April 2020. So the threshold drop from £9,100 to £5,000 directly increases the Employer NI bill for any salary above £5,000.

The optimal salary level for 2025/26

For a sole director company without the Employment Allowance, the optimal salary is now £5,000 per year, exactly at the new secondary threshold. This preserves the National Insurance credit toward State Pension qualification (which requires earnings at or above the Lower Earnings Limit of £6,500). To be precise:

The Lower Earnings Limit (LEL) for 2025/26 is £6,500 per year. A salary of £5,000 falls below the LEL, which means no State Pension credit year is earned at that level. For directors who care about qualifying years, the correct optimal salary is £6,500 - paying a small amount of Employee NI but earning the qualifying year. For those who already have sufficient qualifying years or are not concerned, £5,000 is marginally cheaper.

The extra £1,397 net cost of Option B buys a qualifying year toward the new State Pension (currently worth approximately £328 per year in retirement, index-linked). Over a 20-year retirement, that's around £6,500 in today's money - significantly more than the cost. For most directors who still need qualifying years, Option B is the right choice.

The full picture: salary plus dividends

Assuming a director with no other income, a salary of £6,500, and profit available for extraction after CT, the dividend tax rates for 2025/26 are:

The personal allowance of £12,570 offsets the salary, so a director on £6,500 salary has £6,070 of personal allowance remaining. The first £6,070 of dividends is tax-free (absorbed by the remaining personal allowance). The next £500 is covered by the dividend allowance. After that, dividends are taxed at 8.75% up to the basic rate limit.

That's an effective total tax rate of 29.8% on the original £80,000. Two things drive it. At £73,275 of taxable profit the company sits in the marginal relief band above the £50,000 small profits threshold, so CT is charged at an effective rate above 19%. And because total income of £64,107 runs well past the £50,270 basic rate limit, £13,837 of the dividend is taxed at 33.75% rather than 8.75%.

It is worth being precise about the personal allowance here, because this is where the arithmetic most often goes wrong. The salary consumes £6,500 of it first, so only £6,070 is left to set against dividends. Applying the full £12,570 to the dividends as well as taking the salary counts the same allowance twice and understates the bill by roughly £4,000.

Even so, this remains meaningfully more efficient than paying the whole £80,000 as salary once Employer and Employee NI are added in. The gap is just narrower than the headline "salary to the threshold, rest as dividends" advice tends to suggest at this level of profit.

Where it breaks down: the higher rate boundary

Once total income (salary + dividends) exceeds £50,270, dividends enter the higher rate band at 33.75%. The worked example above is already past that line, which is exactly why its effective rate lands near 30% rather than the mid-twenties. For most director-shareholders, this is the point where simply maximising dividends stops being the right strategy and more active planning is needed.

Common approaches at this level include:

• Splitting dividend income between a spouse or civil partner (genuine shareholding required. HMRC's settlements legislation at s625 ITTOIA 2005 applies if the arrangement lacks commercial reality)
• Pension contributions made directly by the company. No CT on the premium, no NI, no personal income tax. The most efficient extraction route for higher earners.
• Leaving profit in the company if the higher rate tax cost of extraction exceeds the benefit of accessing the cash

The key numbers to hold for 2025/26

What to review before year end

The salary/dividend split is not a set-and-forget decision. Three things are worth reviewing in Q3 of each tax year (January–March), before the year end creates fixed facts:

1. Profit trajectory: If profit will stay below £50,000, the 19% small profits rate is locked in and dividends remain efficient. If profit is heading toward the marginal band, the analysis changes.
2. Dividend cumulation: Has the director received dividends from other sources? A separate investment portfolio or other company shareholding reduces the headroom before the higher rate kicks in.
3. Pension headroom: Annual allowance is £60,000 (2025/26), tapering above adjusted income of £260,000. If there's unused allowance from prior years (carry-forward rules apply for three years), a larger employer contribution before year end can be highly efficient.

The optimal split calculation isn't complex - but it does require current numbers, not estimates from six months ago. The closer you work to real-time figures, the better the advice you can give.