For a limited company contractor, the first extraction decision of every tax year is how much to draw as salary and how much as dividends. Get it right and you pay the lowest legitimate combined tax on the money you take out; get it wrong and you either hand HMRC more than you need to or you trip a threshold that costs far more than it saves. The 2026-27 numbers have moved enough that the tidy rules of thumb contractors quoted three or four years ago no longer give the best answer, so the split is worth resetting from first principles each April rather than carrying last year's figure forward.
The salary-and-dividend split is the central lever in tax-efficient director remuneration, and getting the numbers right for the current tax year is what this comes down to. It assumes a single working director of a Harrow-based personal service company operating outside IR35, since a contract caught by the rules is taxed at source and leaves almost nothing to plan. If you have not settled your status yet, whether you fall inside or outside IR35 changes whether any of this applies to you at all, so settle that first.
Why a Low Salary and Topped-Up Dividends Still Wins
The structure that suits most contractor-directors is a modest salary up to a chosen threshold, then dividends from post-tax company profit for the remainder of what you need. Salary is a deductible cost that reduces the company's corporation tax bill, and it counts towards your qualifying years for the State Pension. Dividends carry no National Insurance at all, which is what makes the blended rate on extracted profit lower than paying yourself a large salary. The company pays corporation tax on its profit first, then you pay dividend tax on what you take, so the two layers have to be read together rather than in isolation.
The reason the old advice needs revisiting is that both National Insurance and dividend taxation have tightened. The employer NI secondary threshold has fallen to £5,000 and the employer rate has risen to 15 percent, so any salary above £5,000 now carries a real company cost. On the dividend side, the tax-free allowance has been cut to £500 and the rates rose from 6 April 2026, so the buffer that used to soak up a couple of thousand pounds of dividends tax-free is now negligible.
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Setting the Salary: the Two Thresholds That Matter
Two figures anchor the salary decision. The first is the personal allowance of £12,570, the point up to which you pay no income tax. The second is the employer NI secondary threshold of £5,000, above which the company pays 15 percent employer NI on the salary. For 2026-27 the ordinary and upper dividend rates are 10.75 percent and 35.75 percent, with the additional rate held at 39.35 percent, as set out in HMRC's guidance on tax on dividends.
Most single-director contractors still set the salary at the £12,570 personal allowance rather than the £5,000 NI threshold. Paying £12,570 does trigger employer NI on the £7,570 above the secondary threshold, which is about £1,135 at 15 percent, but that cost is a corporation-tax-deductible expense, and the extra salary itself reduces the profit that would otherwise be taxed and then extracted as dividends. For a company paying corporation tax in the marginal band, the net cost of running salary up to the personal allowance is usually a few hundred pounds, and it secures the higher State Pension qualifying salary in the process.
A Single Director Cannot Use the Employment Allowance
The £10,500 Employment Allowance that wipes out employer NI is not available to a company whose only employee earning above the secondary threshold is a single director. If you are a sole director with no other staff, budget for the roughly £1,135 employer NI on a £12,570 salary rather than assuming the allowance covers it. A genuine second employee changes the position.
Layering the Dividends on Top
Once salary is set, dividends fill the rest of what you draw. The first £500 of dividends is covered by the dividend allowance and is tax-free, though it still uses up part of your basic-rate band. Above that, dividends falling within the basic-rate band are taxed at 10.75 percent for 2026-27, and dividends that push your total income above the £50,270 higher-rate threshold are taxed at 35.75 percent. Income above £125,140 attracts the 39.35 percent additional rate, and the personal allowance itself tapers away between £100,000 and £125,140, which quietly raises the effective rate in that band.
The practical takeaway is that the first slice of dividends is cheap and the marginal cost climbs sharply once you cross into higher-rate territory. A contractor who only needs to draw up to around the higher-rate threshold keeps the whole dividend stream at the 10.75 percent rate. Someone drawing well beyond it should look hard at whether the top slice needs to come out this year at all, which is where retained profit planning and pension contributions earn their place alongside the split.
- 1Salary of £12,570 uses the personal allowance and generates a qualifying year for the State Pension.
- 2The first £500 of dividends is tax-free under the dividend allowance.
- 3Dividends up to the £50,270 higher-rate threshold are taxed at 10.75 percent.
- 4Dividends above that are taxed at 35.75 percent, and above £125,140 at 39.35 percent.
Do Not Draw More Than the Profit Supports
A dividend can only be paid from distributable profit, meaning accumulated post-tax profit shown in the accounts, not the balance sitting in the bank. Paying yourself a dividend the company has not actually earned creates an unlawful, or ultra vires, distribution that HMRC can recharacterise as a loan to the director, dragging in a Section 455 charge and potentially a benefit-in-kind. The Low Incomes Tax Reform Group explains the mechanics of how dividends are taxed and why the paperwork matters. Keep a board minute and a dividend voucher for every distribution, and check the retained profit figure before each payment.
This is also why the salary-and-dividend split cannot be set once and forgotten. Corporation tax has to be paid before the profit is distributable, so a contractor who front-loads dividends early in the year can find the company short of distributable reserves once the tax and expenses are booked. Reviewing the position quarterly against management figures keeps the extraction inside what the company has genuinely earned.
Where the Split Fits the Wider Plan
The salary-and-dividend decision is the foundation, but it is rarely the whole answer for a profitable contractor. Employer pension contributions, a Relevant Life Policy, and legitimate expenses all reduce the profit you would otherwise extract at dividend rates, and our dividend tax planning service is built around modelling those together rather than in isolation. If you are still weighing whether the limited company route is worth the administration at all, the cost-benefit comparison of a limited company against a PAYE umbrella sets out where the crossover point sits.
For a Harrow contractor the numbers above are the national rules; what changes locally is the mix of clients and day rates, and whether a spouse genuinely shares in the business. We model the optimum split for your actual profit and drawings for the current year, including the employer NI cost and the point at which topping up dividends stops being worthwhile. Tell us your figures through the form on this page and we will show you where the line sits.
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