If you run a UK limited company as a freelancer or contractor, deciding between a salary or dividends is one of the most important tax decisions you’ll make. The choice directly affects how much income tax, National Insurance, and overall take-home pay you receive each year.
This guide from Nexus Accounting explains the dividend versus salary debate clearly and practically for limited company directors across the UK. We’ll break down the tax implications, benefits, risks, and common mistakes so you can pay yourself efficiently and compliantly.
Before diving into the details, here’s a quick overview of what we’ll cover.
Table of Contents:
- What Is a Salary for Limited Company Directors?
- What Are Dividends and How Do They Work?
- Salary Versus Dividend: What’s the Difference?
- Income Tax Rate for Dividends Explained
- How Contractors Typically Combine Salary and Dividends
- When Paying a Higher Salary Makes Sense
- Common Mistakes When Choosing Salary or Dividends
What Is a Salary for Limited Company Directors?
A salary is a payment made by your limited company to you as a director or employee, processed through PAYE.
How Salary Is Taxed in the UK
A director’s salary is subject to:
- Income Tax
- Employee National Insurance
- Employer National Insurance
This means that while salaries are straightforward, they are generally less tax-efficient than dividends for limited company contractors.
Advantages of Taking a Salary
A salary can still play an important role in your remuneration strategy:
- It counts as a business expense, reducing corporation tax
- It provides qualifying earnings for State Pension
- It creates predictable, regular income
For most contractors, Nexus Accounting typically recommends a low, tax-efficient salary rather than a high one.
What Are Dividends and How Do They Work?
Dividends are payments made to shareholders from post-tax company profits. If you operate through a limited company, you are usually both a director and a shareholder.
How Dividends Are Paid
Dividends can only be paid if:
- The company has sufficient retained profits
- Proper dividend paperwork is prepared
- Payments follow shareholding percentages
Dividends are not subject to National Insurance, making them a popular choice for contractors.
Why Dividends Are Popular with Contractors
Dividends offer:
- Lower overall tax burden
- No National Insurance contributions
- Greater flexibility over timing
This is why the salary versus dividend approach is central to contractor tax planning.
Salary Versus Dividend: What’s the Difference?
The dividend versus salary comparison comes down to taxation, flexibility, and compliance.
Key Differences at a Glance
| Factor | Salary | Dividends |
|---|---|---|
| Income Tax | Yes | Yes (lower rates) |
| National Insurance | Yes | No |
| Corporation Tax Relief | Yes | No |
| Flexibility | Fixed | Flexible |
| Based on Profits | No | Yes |
The optimal salary or dividends mix depends on profits, personal income, and long-term planning.
Income Tax Rate for Dividends Explained
Understanding the income tax rate for dividends is essential for accurate planning.
Dividend Tax Bands (UK)
Dividends are taxed at different rates depending on your income band:
- Basic rate
- Higher rate
- Additional rate
While dividend tax rates are lower than salary tax rates, they apply after corporation tax has already been paid.
Dividend Allowance
UK directors also benefit from a dividend allowance, meaning a portion of dividends can be received tax-free each year. This allowance changes over time, making regular reviews essential.
Nexus Accounting ensures clients stay compliant while maximising available allowances.
How Contractors Typically Combine Salary and Dividends
Most limited company contractors use a blended approach rather than choosing one method exclusively.
The Most Common Strategy
Typically, contractors:
- Take a small, tax-efficient salary
- Top up income with dividends
This structure balances:
- Corporation tax efficiency
- Personal tax thresholds
- Long-term benefits such as pension eligibility
When Paying a Higher Salary Makes Sense
While dividends are usually more tax-efficient, there are situations where a higher salary is appropriate.
Scenarios Where Salary Is Beneficial
A higher salary may make sense if:
- Company profits are low or inconsistent
- You need higher mortgage affordability evidence
- You want to increase pension contributions
- Dividend payments are restricted due to retained profit levels
This is why personalised advice from a specialist accountant is essential.
Common Mistakes When Choosing Salary or Dividends
Choosing incorrectly between salary versus dividend can be costly.
Common mistakes to avoid include:
- Paying dividends without sufficient profits
- Failing to document dividends properly
- Ignoring changes to dividend tax rates
- Taking too much income too early in the tax year
- Not reviewing remuneration annually
At Nexus Accounting, we proactively review your remuneration strategy to prevent these issues.
Key Takeaways for Contractor National Insurance
- Salaries are taxed through PAYE and attract National Insurance
- Dividends are paid from post-tax profits and avoid National Insurance
- The income tax rate for dividends is lower than salary tax rates
- Most contractors benefit from a combined salary or dividends approach
- Dividend rules require careful compliance and planning
- Professional advice ensures optimal tax efficiency
FAQs
Is it better to take dividends or salary in the UK?
For most UK limited company contractors, it is usually more tax-efficient to take a combination of dividends and a small salary rather than relying on salary alone. Dividends are not subject to National Insurance and are taxed at lower rates than salary, making them a popular choice when company profits allow. However, the optimal mix depends on profits, personal income levels, and long-term planning.
What is the income tax rate for dividends compared to salary?
The income tax rate for dividends is lower than the income tax and National Insurance combined that applies to salary. While salary is taxed through PAYE and attracts both employee and employer National Insurance, dividends are taxed at specific dividend rates and do not incur National Insurance. This difference is why dividends are often more tax-efficient for limited company directors.
Can I pay myself a salary and dividends
Yes, limited company directors can pay themselves both a salary and dividends, and this is the most common approach for UK contractors. A small, tax-efficient salary is typically used to maintain benefits such as State Pension eligibility, while dividends are taken from company profits to reduce overall tax liability. Proper planning and compliance are essential to ensure dividends are paid correctly.
Elevate Your Tax Strategy with Nexus Accounting
Understanding the difference between salary versus dividend is essential for limited company freelancers and contractors who want to maximise take-home pay while remaining fully compliant. The right balance can save thousands in tax over the life of your company.
At Nexus Accounting, we specialise exclusively in limited company contractor and freelancer accounting, providing tailored advice that adapts as tax rules change. If you want clarity, confidence, and proactive tax planning, our expert team is here to help. Speak to Nexus Accounting today by visiting our Contact Page or explore our Contractor Accounting Services.
