Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only. You should always seek professional advice from an appropriately qualified adviser.
All contents are based on our understanding of current legislation, which is subject to change, any information provided here is only correct at the time of posting.
The Financial Conduct Authority do not regulate will writing, loans, credit cards or some forms of mortgage, tax advice, offshore investments and estate planning.
There is a risk to your capital and you may not get back the full amount invested. The value of investments, as well as the income from them, can fall as well as rise.
Most directors of small companies settled on a way of paying themselves years ago, usually with an accountant, and have not revisited it since. A modest salary, the rest as dividends, and the arrangement runs on in the background without much thought. It was the right answer for a long time. It deserves another look now, because two of the numbers underneath it have moved.
From 6 April 2026 dividend tax rates rose by two percentage points, to 10.75% within the basic rate band and 35.75% within the higher rate band. The additional rate stayed at 39.35% and the dividend allowance is still £500. Separately, employer National Insurance sits at 15% on earnings above a secondary threshold of £5,000 a year, which is a good deal lower than it used to be. Salary and dividends have both become more expensive routes out of the company.
The third route
An employer pension contribution is treated differently from both. The company pays it directly into your pension, and provided it satisfies HMRC's wholly and exclusively test it is an allowable business expense, so it reduces the profit on which corporation tax is charged. There is no employer National Insurance on it and no employee National Insurance either. Unlike a personal contribution, an employer contribution is not capped by your salary, which matters a great deal if you pay yourself £5,000 or £12,570 and take everything else as dividends.
The limit that does apply is the annual allowance, £60,000 for 2026/27 across all contributions from every source. Unused allowance from the previous three tax years can often be carried forward, which is how directors with a good year sometimes put in considerably more than £60,000. If you have already taken flexible income from a pension, the money purchase annual allowance cuts your limit to £10,000, and that catches out directors who started drawing down while still running the company.
What it looks like in practice
Take Ian, 49, a fictional client running a consultancy through his own limited company. He pays himself a small salary, takes dividends to the top of the basic rate band, and leaves a chunk of profit in the company each year because drawing it as a higher rate dividend has never appealed. That reserve has been growing for years and doing very little. Routing part of it into his pension as an employer contribution changes the tax treatment of money he was not spending anyway, and it happens to be the money he will need in about fifteen years.
What it does not do is make him better off in any simple sense, and this is where the enthusiasm needs tempering. The money goes from a bank account he can reach today into a pension he cannot touch until 57, since the normal minimum pension age rises from 55 in April 2028. It is invested once it gets there, so its value can fall as well as rise and he may get back less than was paid in. Tax relief is not a return. If the business needs working capital, or he is planning to sell and wants the reserve visible on the balance sheet, locking it away for a decade is the wrong call whatever the tax saving looks like.
The things that decide it
This is rarely an all-or-nothing choice, and the right mix depends on details that are specific to you:
• Whether you need the money now, or are extracting it because it is there
• Your company's profit level, since corporation tax runs at 19% on small profits and 25% at the main rate, with a higher marginal rate in between
• Whether the salary is enough to protect your National Insurance record for the State Pension
• Whether the company can claim the Employment Allowance, which sole director companies generally cannot
• How much annual allowance and carry forward you actually have available
There is one more consideration that has nothing to do with this year's tax bill. From 6 April 2027 most unused pension funds will be counted as part of your estate for inheritance tax, which removes one of the reasons directors used to favour building up a pension over other assets. That does not undo the case for contributing, since the corporation tax and National Insurance position is unchanged, but it does mean the old answer about what happens to the pot afterwards no longer holds.
Profit extraction sits across the line between accountancy and financial planning, and the best outcomes usually come from your accountant and your adviser looking at it together rather than separately.
In summary
The traditional small salary and dividends arrangement has not stopped working, but it costs more than it did, and an employer pension contribution now looks comparatively more attractive for profit you are not planning to spend. The trade-off is real: you are exchanging money you can reach today for money locked away until at least 57 and exposed to investment risk in the meantime. Which matters more depends on what the business needs and when you want to stop working.
If you run your own company and have not looked at how you pay yourself since the dividend rates changed, we would be glad to go through it with you, alongside your accountant if that is easier. Get in touch with ACJ and we can look at the whole picture.