Should You Pay Yourself Dividends or Salary? Bedford Accountants Expose the Truth

If you are reading this article, chances are you have heard conflicting advice. Your friend might have told you to take everything as dividends because they are "tax free". Your neighbour might have said you must take a salary so lenders take you seriously. Someone online might have told you to take a pound a year as salary and the rest as dividends. I see this confusion constantly.
The reality is that salary and dividends are taxed in completely different ways, they come with different responsibilities, and the wrong mix can cause huge problems for a Bedford business owner.

Let’s explore this clearly and honestly.

Why Salary Still Matters

Salary is employment income. It is processed through payroll and submitted to HMRC through Real Time Information. Even when you are the director of your own company, salary carries significant benefits that many directors overlook.

A salary gives you:

• National Insurance credits, which build your state pension
• A clean income trail for mortgage applications
• A reduction in corporation tax because salary is a deductible business expense
• Evidence that you are legally employed by your company

A modest salary (usually set just below or around the National Insurance threshold) is one of the foundations of director tax planning. It protects your pension record and it is viewed positively by lenders.

The problem appears when directors take too much salary, because this triggers:

• Employee National Insurance
• Employer National Insurance
• PAYE income tax

These extra costs can quickly outweigh any corporation tax savings. This is why most directors take a strategic salary rather than a high one.

The Truth About Dividends

Dividends come from profit, not from turnover. They are the distribution of what is left after the company pays corporation tax and accounts for legitimate expenses. This means dividends cannot be taken unless real profit exists, and that is where many people go wrong.

When dividends are taken without enough profit, you end up with:

• Illegal dividends
• An overdrawn Director’s Loan Account
• Extra corporation tax
• Complicated year end corrections
• Risk during an HMRC enquiry

These consequences are very real. I deal with them every year for new Bedford clients who were not advised properly by their previous accountant.

Despite this, dividends still remain attractive because the tax rate is lower than on salary. However, HMRC has made this benefit far smaller in recent years. A few years ago the dividend allowance was £5,000. Then it became £2,000. Now it is only £500. This reduction alone means that dividends no longer carry the same automatic advantage they used to.
This is a key reason why choosing between salary and dividends today is far less clear cut.

Why Most Directors Should Choose a Combination

For most Bedford limited company owners, the most efficient and safe approach is a blend of the two. A balanced structure typically looks something like this:

• A modest salary, high enough to secure National Insurance credits
• Dividends taken only when the company has sufficient profit
• Withdrawals planned throughout the year instead of taken randomly
• Employer allowances used to reduce National Insurance costs
• Dividends timed carefully to avoid unnecessary higher-rate tax

This combination helps in several ways. Salary supports pension contributions and mortgage applications. Dividends withdraw profit tax efficiently. Together they offer tax savings, structure, and a clear financial trail.

Why Employer Allowance Matters More Than You Think

One of the most underused tools for small companies is the Employer Allowance. This is a government scheme that reduces your employer National Insurance bill by up to £5,000 per year, provided your business qualifies.

If you employ staff, or structure things correctly, a portion of your salary strategy can be supported by the Employer Allowance which reduces or removes employer NI on salaries. This is something I emphasise with clients constantly because it makes the salary component far more attractive.
Many accountants forget to activate this or simply never speak to clients about it. This is money that should be reducing your tax bill every single year.

If you are not using the Employer Allowance to the maximum available, you are missing out.

Areas Where Directors Go Wrong

I see the same issues repeatedly every year. These are the problems that cost directors the most:

Paying themselves entirely through dividends
This might look tax efficient but it destroys your National Insurance record, and you lose years of state pension. It also weakens your mortgage applications because lenders prefer predictable PAYE income.

Taking dividends when the company has no profit
This leads to an overdrawn Director’s Loan Account which can trigger Section 455 tax, benefit in kind issues and HMRC attention.

Not timing dividends properly
A badly timed dividend can push your income into the higher-rate band even when you did not need the funds urgently.

Taking too much salary without using Employer Allowance
This leads to unnecessary National Insurance costs.

Not speaking to their accountant before withdrawing money
Spontaneous withdrawals almost always cause problems later.

Dividends vs Salary: Which Saves More Tax?

This is the question directors always want answered. But the truth is that tax savings depend on:

• Your profit level
• Your PAYE income from elsewhere
• Whether you have rental income
• The availability of Employer Allowance
• Your pension contribution strategy
• Whether your spouse is involved in the business
• Your dividend timing
• Your personal allowances

There is no table online that can answer this accurately without knowing your personal circumstances.
However, I can tell you this with confidence:

The biggest tax savings come from the correct combination, not from choosing one or the other.

Many people still believe dividends are automatically better, but with the dividend allowance reduced and tax rates increased over the years, the advantage is no longer as big. Salaries have become more relevant again, especially when paired with Employer Allowance and planned pension contributions.

How Pensions Change the Entire Picture

Company-paid pension contributions reduce corporation tax and do not create personal tax immediately. This is one of the most tax-efficient tools available to directors.

When planned alongside salary and dividends, pensions can:

• Reduce your corporation tax
• Reduce your dividend tax
• Reduce your income tax
• Build long term wealth
• Keep your Director’s Loan Account healthy

Software cannot plan this. Only a proper accountant does.

How Mortgage Lenders View the Two Options

This is where the decision should never be based on tax alone. Mortgage lenders strongly prefer salary because it is predictable. A director who takes only dividends often struggles to meet lending criteria unless the company has several years of strong profit.

If you plan to buy a home, remortgage or invest in property, you must factor lending into your decision. I see directors sabotage their lending potential because they tried to optimise tax without thinking ahead.

The Decision Today Is Harder Than It Used to Be

Several years ago, the answer was simple. Take a small salary and large dividends. HMRC made that combination incredibly tax efficient.

Today the dividend allowance is tiny, corporation tax has increased for many businesses and the benefits are not as automatic.
This is why choosing salary or dividends is no longer a simple formula. It requires planning, forecasts and proper advice.

The Honest Truth for Bedford Business Owners

Here is my honest conclusion after years of doing this with clients.

There is no single answer. Salary on its own is rarely right. Dividends on their own are often dangerous. A combination is usually the most efficient but only if it is planned properly.

Before you pay yourself anything, you should consider:

• Your company profit
• Your personal income
• Your allowances
• The Employer Allowance
• Your pension strategy
• Your upcoming mortgage plans
• The status of your Director’s Loan Account
• Your long-term goals

A good accountant should walk you through all of this before you take a salary or dividend.

If your accountant has never reviewed your structure or explained dividend legality, pension strategy or employer allowances, then your current setup may not be anywhere near as efficient as it could be.