Frozen tax bands and contractors: what to do about salary and dividends in 2026
Direct Answer
UK income tax bands are frozen until at least 2028, and the dividend allowance has been cut to just £500 per year. For limited company contractors, this means more of your income is taxed at higher rates every year — even if your day rate stays flat. The optimal salary for 2026/27 remains £12,570, with profits above that taken as dividends. But with fiscal drag biting harder each year and pension contributions now a key mitigation tool, your salary and dividend split is worth reviewing properly — not just rolling forward from last year.
What are frozen tax bands and why do they matter now?
Fiscal drag is the mechanism by which a government collects more tax without formally raising rates. It works by holding income tax thresholds fixed while earnings rise with inflation. The personal allowance has been frozen at £12,570 and the higher-rate threshold at £50,270 since 2021 — and the Autumn Budget 2024 confirmed both will remain frozen until at least 2028.
For a contractor earning £70,000 in 2021 who now earns £80,000, a significant portion of that additional income falls into the higher-rate dividend tax band of 33.75% — not because the rules changed, but because the thresholds did not move. That is fiscal drag in practice: a stealth tax rise with no legislation required.
Source: Money Marketing / Royal London, June 2026.
The dividend allowance: from £5,000 to £500 in eight years
The dividend allowance — the amount of dividend income you can receive tax-free each year — has been steadily eroded:
- 2018/19: £5,000
- 2023/24: £1,000
- 2024/25 onwards: £500
A contractor drawing £40,000 in dividends in 2018 had £5,000 sheltered from tax. The same contractor today has only £500 sheltered — with the rest taxed at 8.75% (basic rate) or 33.75% (higher rate). This alone has added hundreds of pounds per year to many contractors' tax bills, with no change in income.
Understanding where you sit relative to the thresholds is now more important than ever. See our salary vs dividend guide for a full breakdown.
Key 2026/27 figures every contractor should know
Personal allowance: £12,570 — no income tax below this level
Dividend allowance: £500 — tax-free dividend income per year
Basic rate dividend tax: 8.75% — applies to dividends within the basic-rate band
Higher rate dividend tax: 33.75% — applies above the £50,270 higher-rate threshold
Corporation tax: 25% on profits above £50,000 (small profits rate 19% up to £50,000)
Higher-rate threshold: £50,270 — frozen until at least 2028
Optimal salary and dividend split in 2026/27
The standard benchmark for most limited company contractors in 2026/27 is a salary of £12,570 — equal to the personal allowance. At this level:
- No income tax is due on the salary
- No employee National Insurance is due (the NI primary threshold is below £12,570)
- The company can deduct the salary as a business expense, reducing its taxable profits
Profits above the salary are then drawn as dividends. The first £500 is tax-free (the dividend allowance). The remainder is taxed at 8.75% within the basic-rate band, rising to 33.75% for higher-rate taxpayers.
With thresholds frozen, this calculation shifts slightly every year even if nothing else changes. It is worth running the numbers at the start of each tax year rather than rolling forward the previous year's split. Autobooks reviews this as part of the standard monthly service — see our contractor accountancy service.
How pension contributions can reduce your tax bill
Employer pension contributions made directly through your limited company are one of the most tax-efficient tools available to contractors right now. Here is why they work well in 2026:
- They reduce company profits before corporation tax. A £10,000 employer pension contribution saves £2,500 in corporation tax at the 25% rate.
- They do not attract dividend tax. Unlike taking profits as dividends, pension contributions bypass income tax entirely — there is no 33.75% higher-rate dividend tax on money going into a pension.
- They are not subject to annual allowance employer restrictions in the same way that personal contributions are, though total pension input must remain within the annual allowance (£60,000 for most people in 2026/27).
With the dividend allowance at just £500 and frozen bands dragging more income into higher-rate territory, employer pension contributions have become a structurally important part of tax planning for contractors — not just a retirement consideration.
MTD for Corporation Tax: why keeping accounts current matters
Making Tax Digital for Corporation Tax is on the horizon for smaller companies. While the implementation timeline has been extended, the direction of travel is clear: HMRC wants more frequent, digital reporting of company finances.
For contractors, this reinforces a point that matters for salary and dividend planning anyway: keeping accounts up to date throughout the year — rather than catching up at year end — makes it far easier to make informed decisions about when and how much to pay yourself.
Contractors who are working from real-time numbers can make better dividend decisions, spot when they are approaching higher-rate thresholds, and adjust pension contributions accordingly. Contractors who only see their numbers at year end are making these decisions blind.
If your current accountant is only in touch at year end, it may be worth reviewing your arrangement. See our guide to IR35 and contractor tax planning for more context on running a compliant, well-organised limited company.
Frequently asked questions
What are frozen tax bands and how do they affect contractors?
Frozen tax bands mean that income tax thresholds — the personal allowance (£12,570) and higher-rate threshold (£50,270) — are held at the same cash level while incomes rise with inflation. For limited company contractors, this creates fiscal drag: as contract day rates and dividend income increase year on year, a greater share of income falls into higher tax bands without any formal rate rise. The dividend allowance has also been cut from £5,000 in 2018 to just £500 in 2026/27, further compressing after-tax income.
What is the optimal salary and dividend split for contractors in 2026/27?
For most limited company contractors in 2026/27, the optimal salary is £12,570 — equal to the personal allowance. This uses the full personal allowance, triggers no income tax on the salary, and avoids employee National Insurance. Profits above this are typically drawn as dividends, taxed at 8.75% (basic rate) or 33.75% (higher rate) after the first £500 dividend allowance. The right split depends on your total income, pension contributions, and other circumstances, and should be recalculated every tax year.
How can pension contributions help contractors reduce their tax bill?
Employer pension contributions made through your limited company reduce the company's taxable profits before corporation tax — saving 25% on the contribution for companies with profits over £50,000. Unlike dividends, these contributions do not attract income tax or National Insurance. With the dividend allowance at just £500 and tax bands frozen, pension contributions are one of the most effective ways for contractors to extract value from their company in 2026.
Are frozen tax bands quietly eating into your take-home pay?
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