Dividends vs salary: how directors take money out

How salary works

A salary is a deductible business cost, so it reduces the company's taxable profit and corporation tax. But it attracts income tax through PAYE and both employee and employer's National Insurance. A modest salary also preserves your state-pension record and can use up your tax-free personal allowance efficiently.

How dividends work

Dividends are paid from profit after corporation tax, so they are not a deductible cost — the company has already been taxed on that profit. In your hands, dividends are taxed at lower rates than salary and carry no National Insurance, which is why a salary-plus-dividend mix is often the most efficient extraction.

The dividend rules that catch people out

You can only pay dividends from available distributable reserves — accumulated post-tax profit. Paying a dividend the company cannot support is unlawful and can be clawed back. Dividends must be properly declared with board minutes and vouchers, not just money taken ad hoc — see directors' loan account for what happens if they are not.

Finding the mix

The efficient mix depends on profit levels, other income, allowances and thresholds, which change from year to year. Most director-shareholders take a small salary to a sensible threshold and the balance as dividends, but the exact split is worth modelling annually with an accountant.

Keeping the company funded

Extracting profit is not the same as the company having cash — dividends drain reserves that the business may need. Keep working capital in the company and use finance for growth, not stripping cash.

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