Tax efficient ways to pay yourself: salary or dividends? Updated for 2016/17

Editors note: originally published 6 April 2012 and republished each year since as changes in tax law were announced.

A common and sensible question that small business owners trading through a limited company often ask is ‘how do I pay myself in the most tax efficient way’?

The answer to this question is refreshingly simple: use a mixture of salary and dividends.


Salary is the term used to describe money paid to you as an employee of the company. Money paid in this way must be taxed at source (i.e. by the company before it is passed to the employee). This scheme is called PAYE (Pay As You Earn) and ensures that companies deduct both income tax and national insurance from employees salaries and pay it directly to the tax man.

Pay £671 per month as salary

Optimising salary is mainly about National Insurance thresholds.  You need to pay enough salary to avoid gaps in your record but not so much that you start to incur National Insurance payments. In most cases you should pay yourself a small salary that falls just below the limit at which national insurance becomes payable. For the tax year 2016/17 this figure is £671 per month.


Dividends are a distribution of profits by a company to its shareholders. As this definition suggests, dividends should only be paid if there is sufficient profit in the company to cover the payment.

Individuals can pay a lower rate of tax on most dividends received from the company

In 2016/17 the way dividends are taxed changed. The new approach is simpler but increases taxes for many people. For the first £5,000 your receive, no tax is payable. After that your dividend is taxed as follows:

  • 7.5% on dividend income within the basic rate band
  • 32.5% on dividend income within the higher rate band
  • 38.1% on dividend income within the additional rate band

If you are using dividends as an alternative to salary then you’ll see quite clearly that the tax savings are significant while you remain within the basic rate.

Don’t worry about tax credits

Tax credits on dividends were part of the pre-2016 tax regime. They are difficult to understand but the good news is that you can now totally forget about them!

You don’t need to worry about the difference between net and gross dividends. The only figure you need think about is the actual cash dividend distributed by the company. This is the figure that should be listed on your Dividend Voucher and the figure you report in your annual tax return.

Remember that profits are taxed at 20%

The reason that dividends are taxed so much lower than salary is because dividends are paid out of profits rather than being a deductible expense like salary. So don’t be fooled by the headline tax rates. The profits of a company are taxed through the Corporation Tax system. For small companies this is at a rate of 20%. So any money available for dividend payments will already be liable to tax at 20%, which must be paid by the company.

Example of tax efficient payment

  • A total of £46,904 from the company is paid out as follows:
    • Salary of 12 x £671 = £8,052
    • Company profits of £38,948, subject to tax at 20%, leaves dividends to pay to you of £30,158
    • No income tax is payable on the first £5,000 and 7.5% on the remaining £25,158 which totals £1,887
  • So total income after tax = £36,323 (total taxable income = £41,561, just below the higher rate threshold).

On this basis the effective tax rate is 22.5% which compares favourably to the 27% you would pay if you put all this cash through as salary (or 38% if you include the employer’s NI contributions). Note that the benefit deceases as your dividend payment exceeds the amounts above because you start to pay the additional 32.5% tax on dividends.

Additional considerations

If you use a good piece of accounting software (check out our ClearBooks review here) then this should create Dividend vouchers for you. Technically you should also approve the payment of dividends at a board meeting and create an official board minute recording this. The belt and braces approach would be to staple a set of management accounts showing sufficient profit to the voucher and board minute. As to how many companies actually do this, I couldn’t possibly speculate 😉

If you want to find out more about day to day management accounting, check out my post on the basics of management accounting for small businesses.

Alternatively, why not read about:

  • James Jordan

    Hi Andrew 

    Could you point in the direction where you got the figure for the 40% upper threshold limit of (42,475) please as I thought it was much lower thank this?

    • Andy Pearson

       Hi James

      Thanks for your comment. It’s a good question. Technically the 2012/13 higher rate of tax applies from £34,371 to £150,000 (see the HMRC site: However, this is on income over and above your personal allowance, which does not incur tax. Your personal allowance may vary (which is why HMRC splits this out) but the £42,475 threshold I mention in the post is based on adding in the standard personal allowance of £8,105.

      Hope that helps.


  • Anthony Halliday


    Informative post. Only thing i’m curious about is employees NI of 13.8%. Doesn’t look like you’ve included this.

    Would be added to the salary reducing the company profits. Or have i missed something?


    • Andy P

      Thanks Anthony. You are right, the 29% figure I mention in the penultimate paragraph is from an employee perspective only. In the context of an owner paying him/herself through the business the saving on employers NI is just as valuable. Taking this into account the effective tax rate tops 40%.

  • Andrew

    If there are 2 directors does that make it 8.5% tax?

    • Andy P

      Hi Andrew. I’m afraid not. The calculations are the same for each director no matter how many there are.

  • JimKirk

    Hi Andy,

    Am I reading the figure for £34,687 wrongly?

    I mean, doesn’t 20% deducted from £43,743 leave you with: £34,987?

    Cheers for this write up!

    • Andy P

      Thanks Jim, good spot. The 6 should be a 9. I’ve corrected the post.

  • Matt

    Hi. I’m paid this way where I work but it is causing me problems as I’m trying to get a mortgage. Problem is I don’t show as having any gross income when I’m paid like this and brokers don’t seem to be able to compensate for this.
    I been offered a much lower amount than someone who earns much less than me! Is there anyway I could use the 20% tax the company pays as gross for my dividends or is there anything else you could recommend?

    • Andy P

      One of my co-directors managed to find a bank that would assess his income on the basis of the aggregate of salary and dividends. He had to prove this by producing his tax returns. The bank was Santander I believer. however, I’m afraid I have no first hand experience of this issue.

  • Aston

    How does the revenue tolerate this? It just seems too easy and with the Treasury cracking down on tax avoidance, surely it is only a matter of time before these schemes get caught and several years of back payments become due? Or am I being too cautious? IR35 for contractors was painful for many.

    • Andy P

      You are right to be cautious but I think the key issue here is that you are not trying to dupe the tax man. This structure only works if you can demonstrate that you are genuinely dividends out of the distributable profits of a legitimate company. So this is just sensibly structuring payments to make the most of the fact that companies are taxed slightly differently to individuals. The tax man has been well aware of this for years so if he thought it was a tax dodge I’m sure it would have been addressed. But, having said that, you need to consider all the information in front of you and make a decision that you feel comfortable with!

  • Aston

    Thank you Andy P. I think a mixture makes sense and easier to live with.

  • jon

    very interesting. what tax do you pay then if you get dividends of 140,000 sterling for example

    • Andy P

      First you ‘gross up’ your dividend (add 10%) to £155,555. Then you add the gross salary paid of £7,956, which takes you to a taxable income of £163,511. Because this figure significantly exceeds £100,000 you lose your personal allowance giving a revised higher tax rate threshold of £31,865. You then pay extra tax on everything over the £31,865 threshold. Your rate would be 21.6% (slightly higher because you edge over the £150K limit), so around £30,296 of tax. Of course you’ll have to check all of this with your accountant (I’m not one!).

  • sas

    Hi Andy – great article, really clear. Its the approach my business partner and I want to follow. What though if we pay ourselves at the end of the tax year in one lump sum. Does that trigger higher NI contributions? thanks

    • Andy P

      Thanks sas. As far as I know it shouldn’t affect your national insurance contributions if you pay the salary in a lump sum at the end of the year. I don’t have personal experience of this though and don’t know if there are any other issues that might arise (it does sound a bit unusual). However, HMRC publish thresholds on a weekly, monthly and annual basis which I assume is to address this situation. Here are the 2013/14 thresholds:

  • vickie

    Thank you that was really helpful

    • Andy P

      Cheers Vicki. Glad you found it useful.

  • Paul

    If you pay yourself a salary below the NI threshold, does that have an impact on your entitlement to the state pension as you will have fewer qualifying years?

    • Andy P

      Good Question Paul. The threshold at which you are deemed to be working and thereby qualify for state pension etc. is the ‘lower earnings limit’. This is £111 per week, or £481 per month for 2014/15. The rate at which NI starts to be charged is higher – currently £663. So if you follow the approach described above you should not run into this entitlement problem.

  • Slady76

    My worry is if I pay myself monthly dividend, what if I don’t show a profit one month or do I just have to show a profit at the end of the year and does that need to be grater than the dividends I’ve paid.
    My accountant doesn’t like dividends due to the fact the company has to pay more.

    Help I’m paying to much tax on salary.

    • Andy P

      If you already engage a professional accountant then you should follow their advice, or if you doubt it try changing accountants. This stuff should be bread and butter advice to any accountant worth its salt. The post is aimed more for people like me – non-accountants trying to figure this out for themselves.

      On your point about profit. You are technically only allowed to pay dividends if your business has sufficient distributable profit. If your profit is very up and down you should lengthen the period over which you pay dividends to each quarter, 6 months or a year. Even then if you don’t have the profit you may need to skip a payment.

  • Dan

    Hi, I have a question that I’m struggling to get a good answer to – hoping someone here can help. I’m looking to set up a business to run part time, but I’m already employed full time in an unrelated line of work as a PAYE employee. Does the same guidance above apply in this case – i.e. should I still pay myself a wage, or can I take full payment in Dividends? Also, in this case, does my personal income include my salary from my other job or is it just from my own company? Any ideas? Cheers

    • Andy P

      Hi Dan. If you are receiving salary from another job then you should probably only pay dividends from your company. If the part time income is less than the salary amounts recommended in this post then you may wish to top them up with a small salary payment from your company. The bottom line is that HMRC doesn’t really mind where ‘salary’ comes from – it treats it all as taxable income.

      • Dan

        Thanks Andy. That really helped to clear things up for me. Very much appreciated. Cheers.

  • Alex

    Hello. This is very interesting. I do have a question: what if you don’t want to have the £663 per month salary and would rather have a higher salary (for example: £2000/month). I would this apply? Would it still be £24k (salary) + £31k (dividends), in which the salary income would be taxed accordingly to the applicable rates? Or would the salary level change the amount of tax efficient dividends?
    Please give me your advice on this scenario (or a similar one your thing is more suitable) for someone who wants to have a higher contributing history (for moral or retirement purposes, just to name a few) 🙂

  • dandelion

    Hi, Im just wondering if it is possible to pay an employee their salary in a lump sum, or should this be made in monthly payments?

    • Andy P

      I’m sure you can pay as a lump sum but you probably need to be careful how you treat it for tax and NI. I imagine you’d do the calculation as if it were 12 monthly instalments even if you paid the cash at the same time. However, you’d need to check that with HMRC or an accountant.

  • Jan Orsula

    Can I take from ltd dividends only, without ever running payroll? For example if my only job is the post of director. Or if I have also another job and pay National Insurance there and don´t want pay any more.

    • Andy P

      Hi Jan. Yes, that’s fine. You don’t have to take a blend of salary and dividends. You are free to take only dividends if you want. This makes sense if you’ve maxed out your personal tax free allowance through income from another job.

  • Caroline

    Hi Andy,
    Thanks for a really helpful article. I have a question: Can I opt not to pay myself a salary or dividends for a period of time/some years if I have other monies coming in (not related to my limited company) that I can live off? (namely some rental income). If this is possible – can I take the ‘deferred’ dividends at some point in the future? Also, if I’m not paying myself a salary, how do I go about keeping up minimum National Insurance payments?

    • Andy P

      Hi Caroline. There should be no problem deferring dividends. You can only pay dividends if you have enough profit in the company but that profit can sit on the books quite happily and be distributed through a dividend when it suits the company. Salary is a bit different – you need to hit the minimum national insurance contribution levels if you want the year to count on your contribution record. I believe you can top this up in future years if you want but I don’t know if that has any downsides.

      • Caroline

        Hi Andy,
        Thanks again. That’s very clear re. deferring the dividends and paying myself enough to hit minimum national insurance levels. To this end I’m also in the process of getting a contributions statement to see how many years I have accrued in order to qualify for a full state pension (as I’ve been told that it’s going to be raised from 30 to 35 years). Caroline

  • Geraldine

    This article has been so helpful. Thank you for it. I wonder if you wouldn’t mind sharing your wisdom as I find this a mind field. My husband and I are just starting a company which should take a gross income of £130,000 this year. Currently, my husband is taking a salary of £40k (just under the higher rate tax band) which leaves us trying to work out the best way to take out more money. We are worried that dividends may mean we become open to IR35 so are wondering if it would be better for me taking the same salary (so 80k out at lower rate tax) and possibly another 10-20k as a dividend at the end of the financial year or whether we should both take the £8062 each with the rest in dividends? Thank you.

    • Andy P

      Hi Geraldine. I’m no accountant but it sounds like your main issue is IR35. The guidance in this post explains how to optimise the situation you describe but it assumes that you CAN safely pay both you and your husband mainly in dividends. It sounds like you need some professional advice on whether or not IR35 applies because otherwise, if you followed the advice in this post, you might at some point find yourself having an awkward conversation with the tax man.

  • Ni

    There must be a better way. I make 40K profit the gov take 10k? Wow that’s insane

  • Maria Ramirez

    Hi Andy, I’m a Spanish thinking into creating a company in Uk (but living in Spain) I plan to do this because I’ll start super-small and Spain it’s not ready to help such small business to start their journey. So, I was planning to get paid by dividend (and maybe an small salary) I have read a lot about Uk dividends and I though that as I live in Spain, I didn’t have to pay any tax on them (in Uk) in Spain I’ll have to pay Spanish tax on them. Am I right?
    Also, I may have an Uk nominee director, just for the sake of doing things right (for the Spanish Hacienda) This director will do nothing and will have not salary or dividends. Is this possible at all? Thanks!!

    • Andy P

      Hi Maria. Sounds like an interesting plan. I’m afraid I don’t anything about tax in Spain so can’t help. Perhaps you could give the tax office in Spain a call? The UK equivalent are always pretty helpful on these kinds of questions.

      • Maria Ramirez

        Will do so, thanks Andy!