One of the main tax advantages of operating through a limited company is the flexibility to choose how and when you extract money from it. Unlike a sole trader — who pays income tax and National Insurance on all profits — a limited company director can combine salary, dividends, and pension contributions in a way that minimises the total tax paid by both the company and the individual.
Getting this right can save thousands of pounds per year. Getting it wrong — whether by paying too much salary, ignoring dividends, or overlooking pension contributions — means paying substantially more tax than necessary.
The Three Ways to Extract Money From a Limited Company
Directors can take money from their company in three main ways, each with different tax treatment:
1. Salary: Treated as employment income. Subject to income tax via PAYE and both employee and employer National Insurance. Deductible as a company expense, reducing Corporation Tax.
2. Dividends: Paid from after-tax profits. Not subject to National Insurance. Taxed at dividend rates which are lower than income tax rates for the same income level. Not deductible for Corporation Tax.
3. Employer pension contributions: Paid directly from the company into your pension. Not subject to income tax or NI. Fully deductible for Corporation Tax. No personal tax on the contribution.
The optimal structure combines all three to minimise the total tax burden across the company and the individual.
The Optimal Salary for 2026/27
Most directors' accountants recommend setting salary at or just below the National Insurance Secondary Threshold — the point at which employer NI starts to be charged.
In 2026/27, the secondary threshold is £5,000 per year (£417 per month). A salary at this level:
- Costs the company no employer NI (employer NI only starts above £5,000)
- Costs the director no employee NI (employee NI only starts above the Primary Threshold of £12,570)
- Is still deductible as a company expense, saving 19% Corporation Tax on £5,000 = £950
- Counts as a qualifying year for State Pension purposes (provided it is above the Lower Earnings Limit of £6,396 — if your salary is below this, you lose the State Pension year)
For most one-director companies, the optimal salary in 2026/27 is £9,100 — above the Lower Earnings Limit (protecting State Pension entitlement) and below the Primary Threshold (no employee NI). The company gets Corporation Tax relief on the salary and no employer NI is due.
Taking Dividends
After paying corporation tax on profits, the remaining retained profits can be distributed as dividends. Dividends are taxed at significantly lower rates than salary:
| Band | Dividend tax rate 2026/27 |
|---|---|
| Within personal allowance (up to £12,570) | 0% |
| Dividend allowance (first £500) | 0% |
| Basic rate (up to £50,270 total income) | 8.75% |
| Higher rate (£50,271 to £125,140) | 33.75% |
| Additional rate (above £125,140) | 39.35% |
Taking a salary of £9,100 leaves £3,470 of your personal allowance unused. Dividends up to £3,470 plus the £500 dividend allowance = £3,970 of dividends are tax-free. Dividends above this up to the basic rate limit (£50,270 total income) are taxed at 8.75%.
The Numbers — An Example for 2026/27
Company profit before extraction: £80,000
Director salary: £9,100 (deductible — reduces company profit to £70,900)
Corporation Tax at 19% on £70,900: £13,471
Retained profit available for dividends: £57,429
Director takes £40,000 in dividends:
- Personal allowance remaining after salary: £3,470 — tax-free
- Dividend allowance: £500 — tax-free
- Remaining £36,030 taxed at 8.75% = £3,153
Total tax paid by director: £3,153 income tax, zero NI
Total tax paid by company: £13,471 CT
Total tax on £49,100 extracted: £16,624
Equivalent sole trader tax on £49,100 profit: approximately £11,700 income tax + £3,200 NI = £14,900
At lower income levels the sole trader can be cheaper. But at higher extraction levels and with pension contributions, the limited company wins significantly.
Employer Pension Contributions — The Most Tax-Efficient Extraction
Employer pension contributions paid directly from the company are:
- Fully deductible against Corporation Tax (saving 19p per £1 contributed)
- Not subject to income tax when contributed
- Not subject to National Insurance
- Tax-free growth within the pension
A £20,000 employer pension contribution from the company saves £3,800 in Corporation Tax, is not taxed as income, and builds your retirement fund. Compared to extracting £20,000 as a dividend at 8.75% (costing £1,750 in dividend tax after allowances), the pension contribution is substantially more efficient for longer-term planning.
The annual pension allowance is £60,000 in 2026/27 (reduced for very high earners). Unused allowance from the previous three years can be carried forward.
What Has Changed for Directors in 2026/27
The employer NI secondary threshold dropped from £9,100 to £5,000 from April 2025, meaning companies pay 15% employer NI on salary above just £5,000. This materially changed the optimal salary calculation for directors in companies that cannot claim the Employment Allowance.
The dividend allowance has been reduced to £500, down from £5,000 in 2017/18. Every £500 reduction has steadily increased the tax cost of dividend extraction for basic rate taxpayers.
Client B was a sole IT contractor in Harrow paying himself £70,000 per year entirely as salary from his limited company. He had never reviewed his extraction structure since incorporating five years ago. His employer NI alone was costing the company £9,750 per year on salary above £5,000.
We restructured his pay to £9,100 salary, £40,000 dividends, and a £20,900 employer pension contribution. The company paid CT on its profits, the director's personal tax reduced dramatically, and employer NI dropped from £9,750 to zero. Total annual saving versus the old structure: over £11,000.
Frequently Asked Questions
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