When you run an owner‑managed SME, one of the most common—and frustrating—questions is: how much should I pay myself as salary, and how much as dividends? I see this with almost every client: founders want to take a sensible income, minimise tax and National Insurance, keep the company cash‑positive, and remain compliant. There isn’t a one‑size‑fits‑all answer, but there’s a clear method you can follow to calculate a fair and efficient split.
Why the split matters
Paying yourself entirely as salary means you’ll be liable for income tax and National Insurance contributions (NICs) through PAYE, and the company will pay employer NICs. Paying entirely as dividends avoids NICs but dividends are taken from post‑tax profits (you pay corporation tax first). The optimal mix balances:
Personal tax and NICs you payEmployer NICs and cash cost to the companyCompany’s retained profits and cashflow needsYour entitlement to state benefits and pension accrual (which are often linked to NICs)I usually recommend a pragmatic approach that combines a modest salary (to use your personal allowance and preserve pension/NIC credits) and the remainder as dividends. Here’s how I break that down for clients.
Step‑by‑step method I use
Follow these steps to calculate a sensible salary/dividend split. I note where you must check current thresholds and rates—these change, so confirm the latest figures with HMRC or your accountant before finalising.
Work out the company’s distributable profits. Start from projected net profit before owner remuneration (i.e. profit after allowable expenses but before director salary and dividends). This tells you how much cash is realistically available.Decide on a salary level that makes sense. For many owner‑directors I advise a salary that: a) uses the personal allowance (so you don’t pay income tax on that portion), b) sits at or above the NIC lower/primary threshold if you want qualifying years for state pension, or below NIC thresholds if you’re optimising NICs.Most commonly I see salaries set around the personal allowance (£12,570 in recent years) or slightly below the threshold for employer NICs so the company avoids employer NICs. Which option you choose depends on whether you value NIC contributions for state pension, benefits or want to minimise employer NICs.
Calculate corporation tax saving by paying salary. Salary is an allowable expense for the business, so it reduces taxable profits and therefore corporation tax. That makes salary cheaper for the company than it looks at face value. Remember to use the current corporation tax rate when doing the calculation.Pay dividends from post‑tax profits. After corporation tax is applied to profits, the remaining distributable amount can be paid as dividends. Compare the net cash to you after dividend tax with the net cash from salary to decide the split.Check marginal tax rates and dividend allowances. Dividends have their own tax rates and an annual dividend allowance; beyond that, dividends fall into your personal tax bands. When you’re close to higher rate bands, the tax on additional dividends increases substantially.Model a couple of scenarios. I always run at least two scenarios: (1) low salary + high dividends, and (2) salary up to personal allowance + lower dividends. Look at company cash after employer NICs and pension costs, and your net personal take home.Worked example (illustrative numbers)
Below is a simplified worked example using assumed tax rates for clarity. Please substitute current HMRC rates and thresholds when you run your own calculation.
| Item | Scenario A: low salary | Scenario B: salary using personal allowance |
| Company profit before pay | £60,000 | £60,000 |
| Director salary | £8,840 | £12,570 |
| Profit after salary | £51,160 | £47,430 |
| Assumed corporation tax @ 19% (illustrative) | £9,720 | £9,012 |
| Profit available for dividends | £41,440 | £38,418 |
| Personal tax/NICs on salary (illustrative) | £0 employee NIC (below PT for example) | £0 income tax (within personal allowance) |
| Dividend tax (assuming basic band) | depends on your other income | depends on your other income |
This shows how salary reduces corporation tax, increasing the amount available for dividends. The best net outcome depends on dividend tax rates and your other income. Use a spreadsheet to plug in current rates and your actual company profit.
Practical checks I always do with clients
Cashflow test: Don’t over‑extract. Company needs working capital, VAT, PAYE & NIC payments, supplier invoices and seasonal cushions. Even if tax rules would allow maximising dividends, keep cash in the business for stability.Director’s responsibilities: If you later need to reinvest or raise finance, lenders and investors will look at retained profits and how you paid yourself.Pension contributions: Employer pension contributions are excellent tax‑efficient ways to extract profit. They’re deductible for corporation tax and free of NICs for the recipient in many cases. Consider paying employer pension contributions instead of dividends if you want to build long‑term wealth.Record keeping: Ensure you have minutes authorising dividends and that dividends are only paid out of distributable profits. Mistakenly paying unlawful dividends can create personal liability.Common pitfalls and how to avoid them
Ignoring NICs and state benefits: Some directors avoid NICs entirely by keeping salary extremely low—but that can reduce your state pension entitlement. If you care about the state pension, factor in the NICs consequences.Forgetting employer NICs and pension costs: A higher salary triggers employer NICs and auto‑enrolment pension employer contributions. Put those figures into your model.Not updating for changing rates: Tax rates, thresholds and dividend allowances change. I always recheck numbers at year‑end and before any major distribution.Paying dividends without sufficient distributable reserves: Always check the company’s retained earnings. Directors can be personally liable for unlawful distributions.Tools I use and recommend
I often model scenarios in a simple spreadsheet—columns for profit, salary, employer/employee NIC, corporation tax, dividends and net cash to director. If you want, I can share a template for this.Accounting software like Xero, QuickBooks or FreeAgent lets you tag director salaries and dividends, and produces trial balances that make checking distributable reserves easier.For detailed tax band calculations I use HMRC’s calculators or professional tax software, because dividend tax rates and allowances change frequently.If you’d like, give me a quick run‑down of your company profit, any other personal income, and whether you want to prioritise pension contributions or state pension qualifying years. I’ll walk you through a tailored split and can prepare a simple spreadsheet so you can test different scenarios without getting lost in the numbers.
