Optimal Director Salary in 2026/27: The £12,570 vs Lower Salary Decision

Setting the right director salary is one of the most frequently discussed topics in UK small business tax planning, and for good reason: the difference between the three main strategies can be worth several hundred pounds per year in cash, compounded over a career by State Pension entitlement effects. Here is the definitive 2026/27 analysis.

The 2026/27 Thresholds You Need to Know

Key NI rates:

• Employee NI: 8% on earnings between Primary Threshold and £50,270; 2% above
• Employer NI: 13.8% on earnings above Secondary Threshold (£9,100)
• Employment Allowance: up to £5,000/year credit against employer NI (eligible companies only)

The Three Salary Options

Option 1: £0 Salary — No Payroll

Take nothing as salary; draw all money as dividends.

NI implications: No NI payable by employee or employer. However, years with earnings below the LEL (£6,396) do not count as qualifying years for the State Pension. You miss out on building entitlement at no corresponding tax saving.

Income tax: No tax on zero salary.

State Pension impact: Every qualifying year missed reduces your eventual State Pension. In 2026/27, the full new State Pension is approximately £11,502/year (35 qualifying years required). Losing one qualifying year costs roughly £329/year in State Pension from retirement onwards — potentially for 20+ years of retirement. That can cost £6,000+ over a retirement, for zero tax saving.

Conclusion: £0 salary is generally the worst option unless there is a very specific reason (e.g., you are already accumulating qualifying years elsewhere, perhaps as an employee in a part-time role).

Option 2: £6,396 — Lower Earnings Limit

Pay yourself a salary exactly equal to (or just above) the Lower Earnings Limit.

NI implications:

• Employee NI: £0 (earnings are below the Primary Threshold of £12,570)
• Employer NI: £0 (earnings are below the Secondary Threshold of £9,100)
• State Pension: qualifying year earned — HMRC treats you as having paid NI even though no NI is actually due

Income tax: £6,396 is well within the personal allowance — £0 income tax.

Salary cost to company: £6,396 (fully deductible against corporation tax at 19–25%, worth £1,215–£1,599 in tax saving)

Payroll admin: PAYE scheme must still be registered and RTI submissions made monthly (even though the payments are £0 — employer NI payment submissions are still required). Many payroll software packages handle this automatically.

Conclusion: £6,396 is the safest option for sole-director companies not eligible for Employment Allowance. Zero NI cost, earns a State Pension year, reduces the corporation tax base.

Option 3: £12,570 — Personal Allowance / Primary Threshold

Pay a salary equal to the personal allowance and the employee NI primary threshold.

NI implications:

• Employee NI: £0 (earnings do not exceed Primary Threshold of £12,570)
• Employer NI: (£12,570 − £9,100) × 13.8% = £3,470 × 13.8% = £479
• If Employment Allowance applies: £479 is covered — net employer NI = £0
• If EA does not apply: £479 is a real cost

Income tax: £12,570 is exactly equal to the personal allowance — £0 income tax.

State Pension: qualifying year earned (as at £6,396).

Salary cost to company (EA-eligible): £12,570 salary, £479 employer NI (offset by EA), net cost = £12,570 deductible against CT. CT saving: £12,570 × 19% = £2,388 (small profits rate) or up to £3,143 at 25%.

Salary cost to company (not EA-eligible): £12,570 + £479 employer NI = £13,049 total. The £479 is an extra cash cost compared to the £6,396 strategy.

Benefit of £12,570 over £6,396: Additional salary of £6,174 deductible against CT, saving £6,174 × 19% = £1,173 in corporation tax (at small profits rate) — but if paid as dividends instead, the company would pay CT on those profits and you would pay dividend tax. Let us compare properly.

Full Comparison at Company Profit of £60,000

Assumptions: director only, EA not available (sole director), 2026/27 rates, dividends paid for remaining profits after salary and CT.

Note: £12,570 salary figure above assumes no EA — employer NI of £479 is a real cash cost. If EA were available, net income under the £12,570 option rises to approximately £47,316, making it clearly optimal.

The table shows that even without EA, a salary of £6,396 significantly outperforms £0, and £12,570 performs marginally better than £6,396 on an after-tax basis despite the employer NI cost (because the additional salary deduction reduces CT).

When EA Is Available: £12,570 Wins Clearly

For companies with at least one other non-director employee (making them EA-eligible), the analysis changes significantly. With employer NI of £479 covered by the £5,000 EA:

• £12,570 salary: corporation tax saving vs £6,396 salary = £1,173 extra
• Employer NI cost: £0 (covered by EA)
• Dividend tax saving vs taking that money as dividends: positive

Net benefit of £12,570 over £6,396 salary (EA-eligible): approximately £500–£700/year in combined tax savings, plus identical State Pension position.

Dividend Planning on Top of Salary

Once you have set your salary, remaining profits are distributed as dividends. For 2026/27:

• Dividend allowance: £500 (reduced from £1,000 in 2023/24 — the allowance has been cut significantly in recent years)
• Basic rate dividend tax: 8.75% (above the allowance)
• Higher rate dividend tax: 33.75% (income over £50,270)
• Additional rate dividend tax: 39.35% (income over £125,140)

For most owner-directors with a single company, careful dividend planning means:

1. Paying salary (£12,570 if EA-eligible, £6,396 if not)
2. Using the dividend allowance (£500)
3. Taking further dividends up to the basic rate band limit (£50,270 total income)
4. Deferring higher-rate dividends where possible — either retaining in company or drawing in a future year with lower income

The key planning point is income smoothing: if you can avoid pushing total income above £50,270, all dividends remain in the 8.75% band. If dividends push you into the higher rate, you pay 33.75% on the excess — a significant step up.

Action Plan for Directors in 2026/27

1. Check EA eligibility: sole director + no other employees = not eligible; any other employee = eligible
2. Set salary at £12,570 (EA-eligible) or £6,396 (not EA-eligible)
3. Confirm payroll is registered with HMRC and RTI submissions are set up — even a £6,396 salary requires PAYE registration
4. Plan dividends: estimate annual profit, calculate CT, determine dividend headroom within basic rate band
5. Consider pension contributions as an alternative to dividends — employer pension contributions save employer NI and reduce CT, and contributions do not count towards the income tax higher rate threshold in the same way
6. Review each April — thresholds change; keep the calculation current

The optimal director salary decision is not complex once you know the thresholds and understand Employment Allowance eligibility. Get it right and you save hundreds of pounds per year with no additional risk — just good planning.