How Do I Pay Myself in Year One Salary or Dividends?

At Towerstone, we specialise in accountancy services for start up businesses and have written this article for company founders working out how to take money out of the business. The purpose of this article is to explain the main options, what to consider in year one, and how to keep things tax efficient and compliant, helping you make informed decisions at an early stage.

This is one of the most important financial decisions you will make in your first year of running a limited company, and in my experience, it is also one of the most misunderstood. People often arrive with a strong opinion already formed, usually based on something they have read online or heard from another business owner, and they want a simple answer.

The reality is that there is no single right answer that applies to everyone. How you pay yourself in year one depends on your personal circumstances, how profitable the business is likely to be, how stable your income is, and what you need personally to live on.

I want to walk through this properly, from the ground up, using real world UK rules and practical experience. I will explain what salary and dividends actually are, how each one is taxed, why year one is different from later years, and how I usually help directors decide what makes sense for them.

First, this question only applies to limited companies

Before going any further, it is important to be clear that salary versus dividends is only relevant if you are running a limited company.

If you are a sole trader, there is no salary and no dividends. You simply take drawings, and you pay income tax and National Insurance on your profits through Self Assessment.

So if you are asking this question, I am assuming you are a director and shareholder of a UK limited company, and that you are actively working in the business.

What a salary actually is

A salary is paid through the company payroll, just like any other employee would be paid.

It is subject to PAYE income tax and National Insurance. The company may also have to pay employer National Insurance, depending on the level of salary.

From the company’s point of view, salary is an allowable business expense. That means it reduces the company’s taxable profit and therefore reduces Corporation Tax.

From your personal point of view, salary counts as earned income. It affects your personal tax bands, your entitlement to state benefits, and your qualifying years for the State Pension.

What dividends actually are

Dividends are payments made to shareholders out of company profits, after Corporation Tax has been calculated.

They are not a business expense. They are a distribution of profit.

Dividends are taxed differently from salary. There is no National Insurance on dividends. Instead, you pay dividend tax at rates that depend on your total income.

Dividends can only be paid if the company has sufficient post tax profits. This point is absolutely critical, and it is one of the areas where people get into trouble in year one.

Why year one is different

Year one feels different because everything is uncertain.

Income may be irregular. Profits may not be clear until the year is nearly over. Cash flow is often tight. You may still be building the business while relying on savings or other income.

From experience, this uncertainty is why paying yourself correctly in year one matters so much. Decisions made early on can create problems that only surface months later.

I see many first year directors focus on minimising tax without thinking about cash flow, compliance, or personal financial stability. That usually backfires.

The traditional low salary and dividends approach

You may have heard that the most tax efficient way to pay yourself is a low salary topped up with dividends.

In broad terms, this can still be true, but the detail matters.

A common approach is to pay a salary around the National Insurance threshold, so that you get a qualifying year for State Pension purposes without triggering significant tax or employer National Insurance. Dividends are then used to take additional income.

This approach can be efficient, but it assumes the company is profitable, that dividends are available, and that cash flow supports it.

In year one, those assumptions are not always safe.

The risks of relying too heavily on dividends in year one

From experience, dividends cause more first year problems than salary.

The biggest issue is that dividends can only be paid from profits. Many new directors take money out assuming the company will be profitable by year end, only to discover later that profits are lower than expected.

When that happens, what was taken as dividends may actually be treated as a director’s loan. That can create tax charges, compliance issues, and stress.

Another issue is personal tax planning. Dividends are taxed after the end of the tax year, often long after the cash has been spent. If you do not plan ahead, you can find yourself with a personal tax bill and no cash set aside to pay it.

In year one, when everything feels uncertain, this risk is amplified.

The case for paying a salary in year one

In my experience, a modest salary in year one often provides stability.

Salary is predictable. It is taxed in real time through PAYE. There are no surprises later. You know exactly what you are taking home, and the tax is dealt with as you go.

For directors who are relying on the business income to cover personal living costs, this certainty can be invaluable.

A salary also creates a clear paper trail. It helps with mortgage applications, benefits assessments, and general financial planning.

While salary may not always be the most tax efficient option on paper, in year one, peace of mind and simplicity often outweigh marginal tax savings.

A blended approach is often the most sensible

What I most commonly recommend in year one is a blended approach.

This usually involves a small regular salary, set at a sensible level, combined with occasional dividends once profits are clear and cash flow allows.

This approach spreads risk. It ensures you have regular income, builds your National Insurance record, and still allows you to benefit from dividend tax rates when appropriate.

The key is timing. Dividends should be declared based on real figures, not assumptions.

How Corporation Tax fits into the picture

It is easy to forget about Corporation Tax when thinking about personal income.

Corporation Tax is paid by the company on its profits. Salary reduces those profits. Dividends do not.

In year one, when profits may be modest, this distinction matters. Paying a salary can reduce or eliminate Corporation Tax. Paying dividends does not.

From experience, many directors focus only on personal tax and forget about the company’s position. The right answer always looks at both together.

Cash flow matters more than tax efficiency

This is something I say often, especially to new directors.

Cash flow matters more than tax efficiency, particularly in year one.

A theoretically tax efficient plan that leaves you short of cash, stressed, or exposed to future tax bills is not efficient in practice.

I have seen many directors regret chasing the lowest tax bill while ignoring stability. I have seen very few regret choosing simplicity in the first year.

Personal circumstances make a huge difference

Your personal situation matters.

If you have other income, savings, or a partner supporting household costs, you may be able to rely more on dividends and accept some uncertainty.

If the business is your sole source of income, a stable salary may be more appropriate.

If you are close to the higher rate tax threshold, dividend planning becomes more important. If you need a mortgage soon, salary may be more helpful.

There is no one size fits all answer, and this is where tailored advice really pays off.

Common mistakes I see in year one

From experience, these are the mistakes that cause the most problems.

Paying dividends without checking profits. Taking money out with no records. Forgetting to run payroll properly. Not setting money aside for personal tax. Assuming advice from friends applies to their situation.

These mistakes are rarely intentional. They come from trying to move quickly without understanding the rules.

Can you change your approach later?

Yes, and this is important.

How you pay yourself in year one does not lock you into that approach forever. As the business stabilises, profits become predictable, and cash flow improves, strategies can evolve.

Many directors move towards more dividend focused planning in later years once the business is established.

Year one is about survival, clarity, and building good habits.

My honest view from experience

In my opinion, in year one, salary often plays a bigger role than people expect.

While dividends can be tax efficient, they rely on profits and good forecasting. In the first year, those things are often uncertain.

A modest salary, possibly combined with carefully timed dividends, usually strikes the right balance between efficiency and stability.

The best decision is the one that lets you sleep at night, pay your bills, and stay compliant, while the business finds its feet.

My final thoughts from

How you pay yourself in year one is not just a tax decision. It is a cash flow decision, a risk decision, and a personal wellbeing decision.

From experience, the directors who do best are the ones who prioritise clarity over cleverness in the early days.

If you are unsure, that uncertainty is a sign to slow down, run the numbers, and get advice tailored to your situation.

There will be plenty of time to optimise later. Year one is about getting it right, not getting it perfect.

If you would like to explore related guidance, you may find How do I prepare management accounts for a lender and How do pre trading expenses work and what can I claim useful. For a wider overview of support for new businesses, visit our Start Up Careers Hub.