Sarah Bradford explores what a tax-efficient profit extraction strategy might look like for personal and family companies in 2025/26.
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The tax year 2025/26 started on 6 April 2025, resetting the tax ‘clock’. Now is the time to plan ahead to ensure that profits from a personal or family company during 2025/26 are withdrawn in a tax-efficient manner.
Painless extractions
As a company is a separate legal entity, if the directors and shareholders wish to use the company’s profits personally, they must extract them. There are various ways in which this can be done, some more efficient from a tax and National Insurance contributions (NICs) perspective than others.
The start of a new tax year is a time to take stock. There are changes to rates and allowances to consider, and personal circumstances may also have changed, which may change the amount of profits needed outside the company for personal use. A strategy that worked for 2024/25 may no longer work for 2025/26.
While there are a number of routes by which profits can be extracted, a popular and tax-efficient strategy is to take a small salary and extract further profits as dividends.
Optimal salary for 2025/26
One of the main advantages of withdrawing at least some profits in the form of a salary is the ability to secure a qualifying year for state pension purposes. This may or may not be a priority. A person needs 35 qualifying years when they reach state pension age to secure a full state pension. Where a director shareholder has yet to reach this, it can be beneficial for the company to pay a salary that is at least equal to the annual lower earnings limit (which for 2025/26 is £6,500), to ensure that the tax year is a qualifying one.
Where the salary paid is between the lower earnings limit and the primary threshold, the earner is treated as having paid notional NICs at a zero rate. This means that they get the benefit of a qualifying year without having to pay any NICs in return.
But what about employer NICs? Unfortunately, for 2025/26, for the employed earner to secure a qualifying year, the employer may need to pay some employer contributions. For 2025/26, the secondary NICs threshold is set at £5,000, which is below the lower earnings limit, so unless the employment allowance is available to offset the secondary contributions or one of the higher secondary thresholds applies (as would be the case, for example, if the director-shareholder was under the age of 21, or an armed forces veteran in the first year of their first civilian employment since leaving the armed forces), some employer contributions will be due. For 2025/26, secondary contributions are payable at the rate of 15%.
Employment allowance
The employment allowance (set at £10,500 for 2025/26) is not available where the sole employee is also a director, as is typically the case in a personal company. Consequently, a personal company will need to pay secondary contributions in 2025/26 where a salary is paid to provide the director-shareholder with a qualifying year. If the director-shareholder is paid a salary of £6,500 for 2025/26 (i.e., the minimum amount needed for the year to be a qualifying one), the cost to the company in terms of employer contributions is £225. This rises to £1,135.50 on a salary of £12,570 – the maximum that can be paid free of primary contributions. In a family company where the employment allowance is available, it may be possible to pay a salary of £12,570 free of both employer’s and employee’s NICs, as long as the allowance has not been used elsewhere. This will depend on the number of employees that the company has and the amount they are paid.
In setting the optimal salary level, it is also necessary to consider whether any tax would be payable. Conveniently, for 2025/26, the personal allowance is set at £12,570 – the same level as the primary threshold. Consequently, as long as the director shareholder has not used their personal allowance elsewhere, a salary of £12,570 can be paid free of both tax and primary NICs. If the employment allowance is available (as may well be the case in a family company scenario), there will not be any employer’s NICs to pay either.
Higher or lower?
If the employment allowance is not available, as will be the case in a one-person company, employer’s NICs of £1,135.50 will be payable on a salary of £12,570. However, as both salary payments and the associated NICs attract corporation tax relief, and the rate of corporation tax (at between 19% and 25%) is more than the rate of employer’s NICs (at 15%), it is worth taking the NICs ‘hit’; the employer’s NICs payable is outweighed by the associated corporation tax savings of paying the salary and associated employer’s NICs.
Once the salary exceeds £12,570, tax becomes due at 20% and employee’s NICs at 8%. The combined tax and employer and employee NICs hit outweighs the associated corporation tax relief, so paying a salary above £12,570 is not tax-efficient.
The optimal salary for 2025/26 is £12,570, regardless of whether any employer’s NICs are due. Once a salary of this level has been paid, it is time to switch to other extraction methods if further profits are needed outside the company for personal use.
Dividends and the dividend allowance
Once a salary of £12,570 has been paid, it is more efficient to pay dividends where retained profits are sufficient to allow this than to pay a higher salary or a bonus. Although the profits from which dividends are paid have already suffered corporation tax, the dividend tax rates are lower than the standard income tax rates, and unlike salary payments, there are no NICs to pay on dividends.
However, before paying a dividend, it is important to check that the company has sufficient retained profits to pay the proposed dividend, as dividends can only be paid from retained profits.
All individuals receive a dividend allowance (which for 2025/26 is set at £500). The dividend allowance is available in addition to the personal allowance. Dividends sheltered by the allowance are tax-free. The allowance uses up part of the tax band in which it falls (and in this way, acts more as a zero-rate band than a true allowance). Once the dividend allowance has been used up, dividends (which are treated as the top slice of income) are taxed at 8.75%, where they fall in the basic rate band, at 33.75%, where they fall in the higher rate band and at 39.35% where they fall in the additional rate band. There are no NICs to pay.
In family company situations, dividends can be paid to utilise shareholders’ dividend allowances. If the company has an alphabet share structure whereby each shareholder has their own class of share, the dividend payments can be tailored to their personal circumstances. Otherwise, dividends must be paid in proportion to shareholdings.
Once a dividend up to the level of the available dividend allowance has been paid, the question of whether further dividend payments are worthwhile will depend on whether the funds are needed outside the company. As there will be some tax to pay once the allowance has been used, it is cheaper to leave the funds in the company if they are not needed for personal use.
What else?
It can also be tax-efficient for the company to make contributions to the director’s pension if the profits are not needed immediately by the director to meet living costs. The company can make contributions up to the level of the director’s available annual allowance and secure a corporation tax deduction for those contributions. There is no tax for the director to pay on the contributions as they are a tax-free benefit.
Use can also be made of the tax and NICs exemptions for certain benefits-in-kind to extract profits in the form of a tax-free benefit, such as the provision of a mobile phone.
Practical tip
For 2025/26, if the director does not already have the 35 qualifying years needed for a full state pension, paying a salary of £12,570 and extracting further profits as dividends is a tax-efficient way to extract profits from a personal or family company, providing the director with a qualifying year for state benefit purposes in the process.
