A contractor running a personal service company decides, every year, how to turn company profit into personal income. The two main routes are a salary, which is a deductible company expense but bears PAYE and National Insurance, and dividends, which are paid from post-corporation-tax profit and carry no National Insurance but are taxed at dividend rates on the individual. The balance between them, the salary level and the dividend layer on top, is one of the most-searched questions in contracting, and one of the most misanswered.
The honest position is that there is no single optimal salary that fits every company. The right number turns on three things: whether you can claim the Employment Allowance, whether you have other income using your personal allowance, and your corporation tax marginal rate. This guide sets out the framework so you can find the figure that fits your circumstances, rather than copying a headline number that may cost you. If you would rather have it modelled for your company specifically, our contractor accountancy services include profit-extraction planning as standard.
Everything below uses 2026/27 figures (the tax year from 6 April 2026 to 5 April 2027) on the rUK bands. Dividend tax rose for 2026/27, which narrowed the long-standing advantage of incorporating, so figures from earlier years are no longer a safe guide.
The two levers: salary and dividends
A salary reduces the company's taxable profit, so it saves corporation tax at 19% to 26.5% depending on the company's profit level. It is, though, subject to employee National Insurance (8% between £12,570 and £50,270 for 2026/27) and, above the secondary threshold, employer National Insurance at 15%. Income tax also applies above the personal allowance.
Dividends are different. They are paid out of profit the company has already taxed, so there is no further corporation tax saving from paying them, and they carry no National Insurance at all. They are taxed on you personally at the dividend rates, after a £500 dividend allowance. Because dividends escape National Insurance entirely, the standard approach is a low salary topped up with dividends, but the precise salary level is where the planning lives.
It helps to see why a salary is worth taking at all, given that it triggers National Insurance that dividends avoid. The reason is the corporation tax deduction. A salary is an allowable expense of the company, so every pound paid as salary reduces the profit on which the company pays corporation tax. For 2026/27 the small profits rate is 19% where augmented profits do not exceed £50,000, the main rate is 25% above £250,000, and between those limits the main rate applies with marginal relief, giving an effective rate of about 26.5% on profits in that band. A salary that saves corporation tax at 19% to 26.5% can therefore be worth taking even though it bears employee National Insurance and income tax, provided the combined personal tax cost is lower than the corporation tax saved. That trade-off, salary saves corporation tax but bears NIC and income tax, while dividends save no corporation tax but bear no NIC, is the engine behind every salary-and-dividend decision below.
The mechanics of how dividends interact with corporation tax and the company's profit sit in our wider guide to personal service company tax; this page focuses on choosing the split itself.
Salary level: the Employment Allowance fork
The first decision is the salary, and the single fact that drives it is whether your company can claim the Employment Allowance. This allowance is £10,500 for 2026/27 and offsets an employer's secondary Class 1 National Insurance. Crucially, it is not available to a company whose only employee is a single director. That single-director restriction is the fork in the road, and it is why two contractors with identical day rates can sensibly set very different salaries.
If you cannot claim the Employment Allowance (the single-director case)
This is the most common position: one director, no other employees. Without the Employment Allowance, every pound of salary above the secondary threshold attracts employer National Insurance at 15%, so the usual targets sit between two thresholds that often get confused.
- The secondary threshold, £5,000. Above this point the company pays employer National Insurance at 15%. A salary of exactly £5,000 attracts no employer NIC at all.
- The lower earnings limit (LEL), £6,708. This is the point at which the year counts as a qualifying year for the state pension and contributory benefits, even though little or no NIC is actually paid on earnings up to it.
Here is the nuance that the headline numbers miss. A salary of £5,000 avoids employer NIC, but it sits below the £6,708 LEL, so on its own it does not secure a qualifying year. To bank a qualifying year, a single director typically sets the salary at the LEL of £6,708, accepting a small slice of employer NIC, 15% on the £1,708 between £5,000 and £6,708, which is roughly £256, as the price of the qualifying year. Whether that is worth it depends on whether you already have, or can otherwise obtain, the 35 qualifying years needed for a full state pension. There is no clean single figure here: £5,000 minimises employer NIC, £6,708 secures the pension year, and the right choice is a judgement, not a default.
It is worth being precise about why these particular thresholds, and not the personal allowance, anchor the single-director case. For 2026/27 the employee primary Class 1 rate is 8% on earnings between the primary threshold of £12,570 and the upper earnings limit of £50,270. A salary at £6,708 is well below the £12,570 primary threshold, so it bears no employee National Insurance and no income tax: the only cost is the small employer NIC slice above £5,000. That is what makes £6,708 such a clean figure for a single director: it secures the contributory year at almost no tax cost. Push the salary higher, towards £12,570, and you start adding employer NIC at 15% on the slice above £5,000 (with no Employment Allowance to absorb it), which is the cost you weigh against the corporation tax saving in the section below.
If you can claim the Employment Allowance
If the company has a second genuinely employed person on the payroll, for example a spouse doing real, commercially justifiable work, or other staff, it can usually claim the Employment Allowance. That changes the maths. A salary up to £12,570 (the personal allowance and primary threshold) is then usually optimal, because the employer NIC on the salary above the secondary threshold is relieved by the allowance, so there is no net employer NIC cost, while the extra salary still saves corporation tax at 19% to 26.5%. That corporation tax saving outweighs the employee NIC and income tax cost, making £12,570 the efficient target.
The £12,570 question even without the allowance
It is tempting to assume that a single director who cannot claim the allowance should always stay at £6,708. In fact, even without the Employment Allowance, taking £12,570 rather than £6,708 can give a modest net benefit at 2026/27 rates, because the corporation tax saving on the extra salary can exceed the extra employer NIC at 15%. The outcome is close and depends on your corporation tax marginal rate, so it should be modelled, not asserted.
The arithmetic shows why it is genuinely marginal. Lifting the salary from £6,708 to £12,570 adds £5,862 of salary. That extra salary is a corporation tax deduction, so at the 19% small profits rate it saves about £1,114 of corporation tax (and more, around £1,553, if the company is in the marginal band at the effective 26.5% rate). Against that, the extra salary above the £5,000 secondary threshold bears employer NIC at 15%, costing roughly £879 on the relevant slice, plus a small amount of employee National Insurance at 8% on earnings above the £12,570 primary threshold (none arises at exactly £12,570). The corporation tax saved typically edges ahead of the NIC cost, which is the modest net benefit. But the gap is small, it shrinks at the 19% rate, and it depends on the director having no other income that would push the extra salary into a tax-bearing band. The practical reality is that many single-director contractors take £6,708 for simplicity and a clean qualifying year, while others run the numbers and take £12,570. Both can be defensible. This is precisely why we will not publish a one-size-fits-all "the optimal salary is £X": the Employment Allowance fork and your own circumstances decide it.
The dividend layer on top
Whatever salary you set, the rest of the extraction is normally dividends. The 2026/27 dividend rates are:
| Band | Dividend rate (2026/27) | Previous rate |
|---|---|---|
| Ordinary (basic-rate band) | 10.75% | 8.75% (to 5 Apr 2026) |
| Upper (higher-rate band) | 35.75% | 33.75% (to 5 Apr 2026) |
| Additional (above £125,140) | 39.35% | 39.35% (unchanged) |
The ordinary and upper rates rose on 6 April 2026 under Finance Act 2026; the additional rate is unchanged. There is a £500 dividend allowance, which taxes the first £500 of dividends at 0% but still uses up part of the relevant band rather than sitting outside it. Dividends are taxed after your non-savings and savings income, in their own bands, so your salary and any other income are stacked underneath the dividends when working out which band each slice of dividend falls in.
The order of taxation matters
How much of each dividend is taxed at 10.75% rather than 35.75% depends on the order in which income is taxed. Dividends are always taxed last, stacked on top of your non-savings income (salary, rent, pension) and then your savings income. So your salary occupies the bottom of the bands first, and the dividends fill whatever is left of the basic-rate band before spilling into the higher-rate band at 35.75%.
That ordering has a practical consequence for the split. A higher salary uses up more of the basic-rate band, leaving less room for dividends to be taxed at the lower 10.75% rate. This is part of why the salary decision is not simply "more salary is always better": every extra pound of salary not only bears its own NIC and income tax but also pushes a pound of dividend up into a higher band sooner. The £500 dividend allowance helps a little, taxing the first £500 of dividends at 0%, but it is not a true exemption: it still uses up part of the band it falls in, so a basic-rate contractor's £500 allowance occupies £500 of the basic-rate band rather than sitting outside it. The interaction is modest at typical contractor income levels, but it is the reason the salary and dividend decisions cannot be taken in isolation from each other.
Because the ordinary and upper rates rose, the long-standing incorporation advantage narrowed for 2026/27. The salary-plus-dividend mix is still more efficient than an equivalent all-salary package for most outside-IR35 contractors, since dividends escape National Insurance, but the margin is slimmer than it was, which raises the value of the pension lever discussed below. For the detail of how each dividend band is taxed and how to plan around the rate rise, see our focused guide to dividend tax for contractors in 2026/27.
Worked illustration (outside-IR35, single director)
Take a single-director company with £80,000 of profit before the director's salary, no Employment Allowance, and the director with no other income. A common structure for 2026/27:
- Salary £6,708. This secures a qualifying NI year. It reduces company profit and costs about £256 in employer NIC (15% on the £1,708 above the £5,000 secondary threshold). No income tax or employee NIC arises at this level.
- Corporation tax on the balance. The remaining profit, after the salary and the small employer NIC, is taxed at the corporation tax rate applying to the company (19% where augmented profits do not exceed £50,000, with marginal relief above that). The detail of which rate applies is covered in our note on corporation tax for a contractor limited company.
- Dividends from post-tax profit. The director then draws dividends. The first £500 uses the dividend allowance at 0%. Dividends are stacked on top of the £6,708 salary, so they fill the rest of the basic-rate band (up to £50,270 of total income) at 10.75%, and any dividends above that are taxed at 35.75% in the higher-rate band.
Walking the figures through makes the shape clear. Start with £80,000 of profit before the director's salary. Deduct the £6,708 salary and the roughly £256 of employer NIC, leaving about £73,036 of taxable profit. At the small profits rate of 19% (this company's augmented profits are under £50,000 once the director also draws dividends rather than leaving everything in, but for illustration take the company's profit chargeable to corporation tax at the rate applying to it), corporation tax is in the region of £13,877, leaving roughly £59,159 of distributable reserves. Layered on top of the £6,708 salary, the director can draw dividends that fill the basic-rate band up to total income of £50,270 (so about £43,562 of dividends at 10.75% after the £500 allowance), with anything beyond that taxed at 35.75% in the higher-rate band. The director rarely wants to draw every penny: stopping dividends at the £50,270 higher-rate threshold, and leaving the rest in the company or directing it to a pension, keeps the marginal personal tax low.
The figures are illustrative, the corporation tax depends on the company's actual profit level and any associated companies, and the right structure depends on whether the director needs all the income now or can retain some in the company. The point of the example is the shape: a low salary to a defensible threshold, then dividends planned around the £50,270 higher-rate point and, where income is high, the £100,000 personal allowance taper. Change one input, a second source of household income, a spouse on the share register, a high-profit year that justifies a large pension contribution, and the efficient structure moves with it. That is exactly why the answer is a model, not a memorised number.
Planning around the frozen thresholds
The personal allowance (£12,570) and the higher-rate threshold (£50,270) are frozen to April 2031, a freeze extended at the November 2025 Budget. As day rates and dividends rise, more income is pulled into the higher-rate band without any rate changing. This fiscal drag makes a few planning points genuinely valuable rather than marginal:
- The £50,270 higher-rate threshold. Dividends above this are taxed at 35.75% rather than 10.75%, a large step. A contractor who can control the timing of dividends can keep more income in the basic-rate band across two tax years rather than bunching it into one.
- The £100,000 personal allowance taper. Adjusted net income above £100,000 strips away £1 of personal allowance for every £2, creating an effective marginal rate far above 40% between £100,000 and £125,140. Retaining profit in the company or making a pension contribution to keep adjusted net income below £100,000 is often the single highest-value move for a higher-earning contractor.
- Retaining profit. You do not have to distribute all profit in the year it is earned. Profit that has borne corporation tax can be left in the company and drawn as dividends in a later, lower-income year, smoothing income against the frozen bands.
The bigger lever: an employer pension contribution
Fine-tuning the salary by a few hundred pounds matters far less than most contractors think. The genuinely large, tax-efficient extraction is usually an employer pension contribution from the company. It is deductible against corporation tax on a paid basis, carries no employer or employee National Insurance, and is not taxed on the director as income when paid in, subject to the annual allowance.
The annual allowance is £60,000 for 2026/27, measured across all contributions, with three-year carry-forward of any unused allowance. Critically, an employer contribution is not limited by the director's salary, unlike a personal contribution, which is capped at 100% of relevant UK earnings (and dividends are not relevant earnings). That is exactly why a low-salary, high-dividend contractor uses the company route: a personal contribution would be throttled by the tiny salary, but the company contribution is constrained only by the annual allowance and carry-forward.
Compared with drawing the same money as a dividend taxed at 35.75% in the higher-rate band, the pension route is markedly more efficient; the trade-off is access, since pension funds are locked until minimum pension age. The three-year carry-forward adds another dimension to the split decision: a contractor coming off a high-profit year, or one approaching a company sale or wind-down, can sweep unused allowance from the previous three tax years into a single large employer contribution, taking profit out of the company at no income tax and no NIC rather than drawing it as 35.75% dividends. One trap to watch is the money purchase annual allowance, which drops to £10,000 and removes carry-forward for defined-contribution savings once you have flexibly accessed a pension, so a contractor who has already started drawing a pension pot should check this before planning a large contribution.
For how the deduction, the annual allowance and carry-forward work in practice, see our guide to employer pension contributions for contractors. For many contractors, getting the pension contribution right is worth more than any amount of salary tinkering.
When the split does not apply: inside-IR35 income
The salary-and-dividend planning on this page applies to outside-IR35 company profit. Income from an engagement caught by the rules is taxed at source: under the off-payroll rules the fee-payer operates PAYE and National Insurance before the money reaches the company, and under the older intermediaries legislation the company computes a deemed employment payment. Either way that income has already suffered employment-level tax and cannot be redrawn as low-tax dividends.
A contractor with a mix of inside and outside work therefore plans the split only on the outside-IR35 profit, and treats the inside income separately. If you are unsure which of your engagements are inside or outside, that determination drives everything else, and a professional review is the right starting point; our IR35 status and contract review service exists for exactly that. The vertical realities differ by sector too, which is why we publish sector-specific guidance for the contractor types we work with.
A spouse on the payroll or the share register
Two related moves can widen the planning, but both work only where they are genuine:
- A spouse's salary. Where a spouse does real, commercially justifiable work for the company, paying them a salary is a deductible expense, uses their personal allowance, and can make the company eligible for the Employment Allowance, which in turn supports a £12,570 salary for the director. The work and the pay must be real; a salary for no work is not deductible and invites challenge.
- A spouse's dividends. Where a spouse genuinely owns shares in the company, dividends paid to them are taxed at their own rates and can use a second set of dividend bands and allowances. The share ownership must be real, properly constituted and not an artificial arrangement designed only to divert income.
Both routes attract HMRC scrutiny when they are artificial, so documentation and substance matter. Used properly, they can meaningfully reduce the household tax on the same company profit; used as a paper exercise, they create risk rather than saving. The principle that runs through both is substance over form: a spouse's salary has to reflect real work at a commercial rate, and a spouse's shareholding has to be a genuine, full class of ordinary shares carrying real rights and risk, not a paper share retrofitted at year-end to divert income. Where the substance is real, the planning is robust; where it is constructed only to move a tax bill, it is the kind of arrangement HMRC can look through, so this is an area to set up on proper advice at the outset rather than improvise.
Bringing it together: the framework, not a number
The decision tree for a 2026/27 contractor is short:
- Can you claim the Employment Allowance? If yes (a genuine second employee), a salary around £12,570 is usually right. If no (single director), look at £5,000 to £6,708, and decide whether the qualifying NI year at £6,708 is worth roughly £256 of employer NIC to you.
- Do you have other income? Other earnings, a pension, or a spouse's allowances change which band your dividends fall in and whether you risk the £100,000 taper.
- What is your corporation tax rate? The higher your marginal rate (up to 26.5% in the £50,000 to £250,000 band), the more a salary's corporation tax saving is worth, which can tip the £6,708-versus-£12,570 call even without the allowance.
- How much can go to pension? Before agonising over the salary, size the employer pension contribution, because it is usually the bigger lever.
That is the framework, and it is deliberately not a single number. The dividend-rate rise for 2026/27 narrowed the incorporation advantage, the frozen bands make timing matter more each year, and the Employment Allowance fork can change the answer entirely. If you want the calculation done for your company, with your other income and your corporation tax position fed in, that is what our contractor accountancy services are for. We will tell you the number that fits your circumstances, and the reasoning behind it, rather than a figure copied from a generic article.