Why is a salary of £12,570 usually better than £5,000 for directors with Employment Allowance?

With Employment Allowance, the first £10,500 of employer NI is covered. Salary at £12,570 avoids any employee NI and the employer NI of £1,044 is fully absorbed by the Employment Allowance. The salary is also deductible for corporation tax, saving 19–25% CT on £12,570 vs £5,000. Taking a higher salary reduces corporation tax more while avoiding NI entirely if Employment Allowance covers it.

What is the total tax on extracting £100,000 from a limited company in 2025/26?

Assuming £12,570 salary (no Employment Allowance), £87,430 dividends, company profit £100,000: Corporation tax on £87,430 profit ≈ 19–25% depending on total profits. Dividend income taxed at 8.75% basic rate on the first portion in the basic rate band. Total effective rate is typically 40–45% of original profit, compared to 47–62% as a sole trader.

Can I still use salary sacrifice as a limited company director?

Sole directors of their own company typically cannot benefit from traditional salary sacrifice because there is no employment contract independence. However, director-shareholders can make employer pension contributions directly from company profits, which is highly tax-efficient: the company pays no NI on pension contributions and they are deductible for corporation tax.

Does salary count toward my State Pension entitlement?

You need earnings at or above the Lower Earnings Limit (£6,396/year for 2025/26) to earn a National Insurance qualifying year for State Pension purposes. Salary at £12,570 comfortably meets this threshold even though no employee NI is actually paid (you get a notional credit). Dividends do not count toward State Pension entitlement.

Optimal Salary & Dividend Calculator 2025/26

Q: Should I take salary above the personal allowance?

Generally no, unless you have a specific reason (e.g. mortgage applications requiring a higher contracted salary). Salary above £12,570 is subject to income tax at 20%+ and employee NI, which is less efficient than taking that income as dividends taxed at 8.75%. The optimal strategy keeps salary at or below £12,570 and extracts remaining profits as dividends.

Q: What happens if I take a dividend when the company has insufficient retained profits?

Dividends can only legally be paid from retained profits (distributable reserves). If you pay a dividend exceeding distributable reserves, it is an illegal dividend (also called an unlawful distribution). The director may be required to repay it. Always check your company's retained profit position — shown on the balance sheet — before paying dividends.

Calculate Optimal Salary & Dividend Mix

Enter your company's profit and personal tax position to compare two salary strategies. The calculator shows total tax (income tax + NI + corporation tax) and net take-home for each approach.

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Salary vs Dividend Strategy Comparison

Based on 2025/26 rates (England, Wales, NI). Estimates — consult an accountant for your specific position.

The Two Main Strategies for 2025/26

Strategy 1: Salary at Personal Allowance (£12,570)

No employee NI (primary threshold = £12,570 — so no NI due)
Employer NI: (£12,570 − £5,000) × 13.8% = £1,044.66 (offset by Employment Allowance if eligible)
Salary is fully deductible for corporation tax
Remaining profit (after salary + employer NI) is subject to corporation tax, then extractable as dividends
Best for: companies with Employment Allowance, or where CT savings exceed employer NI cost

Strategy 2: Salary at Secondary NI Threshold (£5,000)

No employer NI, no employee NI
Salary still deductible for CT (saving 19–25% on £5,000)
Personal allowance not fully utilised by salary — more income potentially taxed as dividends in basic rate band
Best for: sole directors without Employment Allowance where employer NI cost exceeds CT benefit

Key 2025/26 Change: Employer NI secondary threshold drops to £5,000 (from £9,100) and rate rises to 13.8% (from 13.8% — unchanged rate but lower threshold). This makes the NI cost of Strategy 1 higher than in prior years for sole directors.

2025/26 Key Rates Reference

Item	Rate / Threshold
Personal Allowance	£12,570
Basic Rate (income tax)	20% on £12,571–£50,270
Higher Rate (income tax)	40% on £50,271–£125,140
Employee NI Primary Threshold	£12,570/year (8% above)
Employer NI Secondary Threshold	£5,000/year (13.8% above)
Employment Allowance	£10,500 (if eligible)
Dividend Allowance	£500 (tax-free)
Dividend Tax — Basic Rate	8.75%
Dividend Tax — Higher Rate	33.75%
Corporation Tax (profits ≤ £50K)	19%
Corporation Tax (profits ≥ £250K)	25%

Frequently Asked Questions

What is the optimal salary for a limited company director in 2025/26?

For most sole director/employee companies (not eligible for Employment Allowance), the optimal salary is often £5,000 — avoiding any employer NI entirely. However, if eligible for Employment Allowance, taking a salary of £12,570 saves more corporation tax while remaining NI-free after the EA offsets employer NI. The best choice depends on your specific profit level and whether EA is available.

When can a company use the Employment Allowance?

From 2025/26, the Employment Allowance increases to £10,500 and is available to companies with 2 or more employees (including directors who are not the sole employee/director). Sole director companies with no other employees remain excluded. If eligible, the EA offsets the first £10,500 of employer NI liability — making Strategy 1 (£12,570 salary) more attractive.

What is the corporation tax rate for 2025/26?

The main corporation tax rate is 25% for companies with profits over £250,000. The small profits rate is 19% for profits up to £50,000. Marginal relief applies between £50,000 and £250,000, with an effective rate that tapers from 19% to 25%. The marginal relief fraction is 3/200.

What is the dividend allowance for 2025/26?

The dividend allowance for 2025/26 is £500. The first £500 of dividend income is tax-free. Dividends above this are taxed at 8.75% (basic rate), 33.75% (higher rate), or 39.35% (additional rate), depending on which income tax band they fall into after non-dividend income is counted first.

Should I take salary above the personal allowance?

Generally no — salary above £12,570 is subject to income tax at 20%+ and employee NI at 8%, making it less efficient than dividends taxed at 8.75% in the basic rate band. The exception is if a higher contracted salary is needed for mortgage applications or if you want to maximise pensionable earnings.

How are dividends taxed for a limited company director?

Dividends are paid from post-corporation-tax profit. The first £500 is tax-free. Above that: 8.75% basic rate, 33.75% higher rate, 39.35% additional rate. Dividends sit on top of your income, so non-dividend income (salary, rental etc.) fills tax bands first. This makes the order of income matter significantly for total dividend tax.

What happens if I take a dividend when the company has insufficient retained profits?

Dividends can only legally be paid from distributable reserves (retained profits shown on the balance sheet). Paying dividends exceeding distributable reserves is an illegal dividend. The director may be required to repay it personally. Always check your company's retained profit position before declaring dividends.

Does salary count toward my State Pension?

You need earnings at or above the Lower Earnings Limit (£6,396/year for 2025/26) to earn a National Insurance qualifying year for State Pension purposes. Salary at £12,570 (or even £5,000 — just below the LEL; check with HMRC) comfortably meets this. Dividends do not count toward State Pension entitlement under any circumstances.

Can I make employer pension contributions to reduce corporation tax?

Yes — employer pension contributions are fully deductible for corporation tax (subject to the pension annual allowance of £60,000 in 2025/26) and attract no employer NI. This is one of the most efficient ways for a director to extract value from the company. A £10,000 employer pension contribution saves up to £2,500 in corporation tax at the 25% rate.

What is marginal relief for corporation tax?

Marginal relief applies when company profits fall between £50,000 and £250,000. The effective corporation tax rate tapers from 19% to 25%. The relief formula is: (£250,000 − profits) × (profits / £250,000) × (3/200). In the marginal band, the effective marginal rate on additional profit can exceed 26%, making it worthwhile to keep profits below £50,000 through salary and pension contributions.

How does having multiple companies affect my tax position?

Associated companies share the corporation tax thresholds. If you have two associated companies, each threshold is halved: small profits rate applies up to £25,000 per company; main rate above £125,000. This can increase corporation tax significantly. The definition of associated companies and the rules are complex — consult an accountant if you have multiple companies.

Should I pay myself a salary for mortgage purposes?

Some mortgage lenders require a minimum contracted salary for affordability assessment. If you take most income as dividends, some lenders may not count dividends fully for affordability, or require 2–3 years of accounts. Taking a higher salary can improve your mortgage application but may increase your tax bill. Specialist contractor mortgage brokers can help find lenders who accept dividend income.

Mustafa Bilgic
Financial Content Writer | Business Tax Specialist
Updated: 10 March 2026 | Published: 1 January 2025