Salary vs dividends for limited company contractors — the 2026/27 numbers
Direct Answer
The optimal structure for 2026/27 remains a £12,570 salary plus dividends up to the basic-rate band — but the sums have changed. Dividend tax rates rose 2% across all bands from April 2026. The basic rate is now 10.75%, the higher rate 35.75%. Taking everything as salary still costs around £2,774 more in combined tax and NICs than the salary-plus-dividend approach. The structure still works — but it needs reviewing every year.
What changed from April 2026?
The April 2026 Budget increased dividend tax rates by 2 percentage points across all three bands:
- Basic rate: 10.75% (previously 8.75%)
- Higher rate: 35.75% (previously 33.75%)
- Additional rate: 39.35% (previously 38.1%)
The dividend allowance remains at £500 for 2026/27 — the first £500 of dividend income each year is still received tax-free.
Corporation tax rates are unchanged: 19% on profits below £50,000 (small profits rate), marginal relief between £50,000 and £250,000, and 25% on profits above £250,000.
The optimal salary in 2026/27: still £12,570
For most contractor directors, the optimal salary is £12,570 — the personal allowance threshold and also the point at which employee National Insurance contributions begin.
At exactly £12,570 there is no employee NIC, no employer NIC (for a director who is the sole or main employee), and the salary is fully deductible against the company's corporation tax bill. Taking a higher salary triggers NICs on every pound above the threshold, making it immediately less efficient than taking additional profit as dividends — even at the new higher rates.
If your company makes pension contributions on top, salary at £12,570 still leaves the full pension annual allowance (£60,000 gross) available, and employer pension contributions carry zero NIC and are fully corporation-tax-deductible.
Dividends: how much is still tax-efficient?
With a £12,570 salary using up most of the £12,570 personal allowance, you can take dividends up to the basic-rate band limit of £50,270 before the 35.75% higher-rate charge applies.
That means roughly £37,700 in dividends at the 10.75% basic rate (after your £500 allowance) before you cross into higher-rate territory. Combined with the salary, total extraction reaches £50,270 before higher-rate tax kicks in.
Even at the new 10.75% rate, basic-rate dividends remain cheaper than salary once you factor in the employer and employee NIC that would apply if the same profit were taken as additional salary. The saving versus a pure-salary approach is approximately £2,774 for a contractor extracting to the basic-rate band.
Employer pension contributions: more attractive than ever
With dividend tax rates now higher, employer pension contributions have become a more compelling alternative for extracting surplus profit from a limited company. The key advantages are unchanged but now more pronounced:
- Zero employee or employer National Insurance on contributions
- Zero income tax on contributions (they go into the pension gross)
- Fully deductible against corporation tax — a 19% or 25% saving on the company's profit
- Annual allowance of £60,000 gross (2026/27) available for most contractors
If you are building a pension or have surplus profit above the basic-rate band, pension contributions should now be the first port of call before extra dividends at 35.75%.
Compliance: what HMRC expects
Dividends are not automatic. To pay a valid dividend from your limited company, you need:
- A board resolution approving the dividend payment
- A dividend voucher for each payment, showing the amount and the tax year
- Sufficient retained profits — dividends cannot exceed distributable reserves
- The dividend reported on your Self Assessment tax return for the relevant year
HMRC regularly challenges poorly documented dividends — particularly where they are paid as a series of round-sum payments without vouchers or minutes, or where the company has insufficient profits to cover them. Penalties for incorrect Self Assessment returns can be significant.
If your company pays dividends to a spouse or family member who also holds shares, the settlements legislation applies: the arrangement must have genuine commercial logic and your adviser should review the share structure.
IR35 caveat: this structure only works outside IR35
The salary-plus-dividend structure is only available to contractors whose engagements are genuinely outside IR35. If you are operating inside IR35 — whether caught under the off-payroll working rules with your end-client, or working via an umbrella company — your income from that engagement is treated as deemed employment income, subject to PAYE and NICs.
Inside-IR35 income cannot be extracted as dividends. If you have a mix of inside and outside engagements running through the same limited company, the dividend strategy should be reviewed carefully with your accountant to ensure you are only drawing dividends from profits that are not subject to a deemed payment calculation.
See our IR35 guide for contractors for a full explanation of how the off-payroll rules work.
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