Director Salary and Dividends Guide

As a company director, one of your most important financial decisions is determining how to compensate yourself. This choice impacts not only your personal finances but also your company’s tax position and long-term growth potential. Finding the right balance between salary and dividends can significantly enhance your tax efficiency while helping you achieve both personal financial goals and business objectives.

Understanding Director’s Salary

When you establish a limited company, you automatically become both an owner and an employee. As the director, you have legal responsibilities to manage the company’s affairs, including filing statutory accounts, submitting tax returns, completing confirmation statements, and handling company secretarial duties. These significant responsibilities justify reasonable compensation.

A director’s salary functions like any other employment income and offers several distinctive advantages. First, it provides predictable, regular income that can enhance your financial stability and improve your credit profile. Second, a salary allows you to utilize your personal tax allowance—an opportunity that doesn’t carry forward if unused. Third, salary payments contribute to your National Insurance (NI) record, which determines your eligibility for the state pension and other benefits.

However, the primary disadvantage of salary payments is their tax treatment. For the 2024/25 tax year, income tax rates apply as follows:

• £0-£12,570: 0% (your personal allowance)
• £12,571-£50,270: 20% (basic rate)
• £50,271-£125,140: 40% (higher rate)
• £125,141 and above: 45% (additional rate, with personal allowance eliminated)

Beyond income tax, both you and your company must make National Insurance contributions on salary payments. These additional costs can significantly reduce the net benefit of salary income compared to other compensation methods.

The Dividend Alternative

Dividends represent distributions of company profits to shareholders. As the director of your limited company, you’re likely also a significant (if not the sole) shareholder, making dividends an attractive compensation option. Unlike salaries, dividends can only be issued when the company has sufficient profits after accounting for all expenses and taxes.

The most compelling advantage of dividends is their preferential tax treatment. For 2024/25, dividend tax rates are substantially lower than income tax rates:

• First £500: 0% (dividend allowance)
• Basic rate band: 8.75%
• Higher rate band: 33.75%
• Additional rate band: 39.35%

This tax differential creates significant savings opportunities. For example, a basic rate taxpayer would pay 20% income tax on salary but only 8.75% on dividends—a difference of 11.25%. Moreover, dividends don’t attract National Insurance contributions from either the employee or the employer, creating additional savings.

Dividends also offer greater flexibility than salaries. You can adjust dividend payments based on company performance, taking larger distributions during profitable periods and reducing or eliminating them during leaner times. This flexibility helps preserve company cash flow while still rewarding shareholders when appropriate.

However, dividends come with important limitations. First, they can only be distributed from profits, making them less reliable than salary during challenging business periods. Second, they don’t count toward your “net relevant earnings” for pension contribution purposes, potentially limiting your retirement planning options. Third, relying exclusively on dividends may create gaps in your National Insurance record, potentially reducing your state pension entitlement.

Optimizing Your Compensation Strategy

The most tax-efficient approach typically combines both salary and dividends. Here are three strategic salary levels to consider:

1. The Lower Earnings Limit Approach (£6,396 in 2024/25)

Setting your salary at the Lower Earnings Limit (LEL) of £6,396 offers several advantages. At this level, you incur no income tax liability, no personal National Insurance contributions, and no employer’s National Insurance obligations. Despite making no actual NI payments, this salary level still counts toward your NI record, preserving your state pension entitlement.

However, it’s important to note forthcoming changes. From April 2025, the LEL will increase to £6,500, while the secondary threshold (relevant to employer contributions) will decrease to £5,000. This means companies will need to pay the employer’s NI (approximately £225 annually) on salaries at the LEL level.

2. The Personal Allowance Approach (£12,570 in 2024/25)

Setting your salary equal to the personal allowance threshold (£12,570) maximizes your tax-free income. At this level, you won’t pay income tax or personal National Insurance contributions. However, since this amount exceeds the secondary threshold (currently £9,100), your company will incur the employer’s NI liabilities of approximately £480 annually.

This liability will increase significantly in April 2025 when the secondary threshold decreases to £5,000, and the employer’s NI rate increases from 13.8% to 15%. Under these new parameters, a salary of £12,570 would generate a company NI liability of approximately £1,135 annually.

3. The Employment Allowance Approach

For companies with multiple directors or at least one director plus one employee, the Employment Allowance presents valuable opportunities. This allowance (currently £5,000 for 2024/25) offsets the employer’s NI liabilities, enabling higher salary payments without corresponding NI costs.

For example, if your company has two directors earning equal salaries, each could receive up to £27,200 without triggering the employer’s NI obligations. At this level, each director would pay approximately £2,926 in income tax and £1,170 in employee’s NI, but the company would incur no employer’s NI costs thanks to the Employment Allowance.

The Employment Allowance is set to increase to £10,500 in 2025/26, potentially allowing even higher salaries (up to £40,000 each for two directors) without the employer’s NI liabilities.

Tax Efficiency Considerations

When formulating your compensation strategy, remember that both salary payments and employer’s NI contributions count as business expenses. These expenses reduce your company’s taxable profit, lowering your corporation’s tax liability. After accounting for these deductions and paying corporation tax on the remaining profits, you can distribute dividends as desired.

This interplay between personal and corporate taxation creates opportunities for optimization. In general, the most tax-efficient approach for most directors includes:

1. A salary at or near the optimal threshold based on your specific circumstances (LEL, personal allowance, or higher if Employment Allowance applies)
2. Dividend payments for additional income needs
3. Strategic timing of dividend payments to manage personal tax liabilities
4. Consideration of alternative compensation methods for high-income scenarios

Beyond Salary and Dividends

As your business matures and your income increases, you should explore additional compensation strategies. These might include:

• Pension contributions: Company contributions to your pension aren’t subject to income tax or National Insurance, making them highly efficient.
• Interest on director loans: If you’ve loaned money to your company, you can receive interest payments at commercial rates.
• Rental income: If you own property used by your business, you might structure a rental arrangement.
• Expense reimbursements: Legitimate business expenses paid personally can be reimbursed tax-free.
• Employee benefits: Certain benefits (like health insurance or company cars) may offer tax advantages in specific circumstances.

Adapting to Tax Changes

The UK tax landscape is constantly evolving. Recent announcements suggest significant changes to National Insurance thresholds and rates beginning in April 2025. These changes will alter the calculus of optimal compensation strategies, potentially making salary less attractive relative to dividends.

It is essential to stay informed about tax changes and periodically review your compensation structure with a qualified accountant. What works today may not be optimal tomorrow, and proactive adjustments can save substantial sums over time.

Tax Advice from Us 

There is no universal “right answer” for director compensation. The optimal strategy depends on your specific circumstances, including your company’s profitability, your personal financial needs, your retirement planning goals, and your risk tolerance.

For most directors, a combination of salary and dividends offers the best balance of tax efficiency, financial security, and flexibility. By setting your salary at a strategic threshold and supplementing with dividends as company profits allow, you can minimize your overall tax burden while maintaining financial stability.

Remember that tax efficiency, while important, shouldn’t be your only consideration. Your compensation strategy should also support your broader business objectives, personal financial goals, and retirement plans. Working with qualified financial advisors can help you develop a comprehensive approach that balances these various priorities effectively.

If you’re uncertain, call our tax advisors or send us an email for further clarification.