The UK’s tax-free dividend allowance has been slashed in successive years, falling from £2,000 in 2022-23 to just £500 in 2025-26. This change significantly affects two groups: individual investors holding shares outside an ISA, and company directors who take income as a combination of salary and dividends. For both, paying tax on dividends is now much harder to avoid.
The Dividend Allowance Timeline
| Tax year | Dividend allowance |
|---|---|
| 2022-23 | £2,000 |
| 2023-24 | £1,000 |
| 2024-25 | £500 |
| 2025-26 | £500 |
The allowance has been held at £500 since 2024-25. At this level, it covers only a very modest dividend income — roughly the annual dividends from a £10,000–£15,000 equity investment, depending on the yield.
Dividend Tax Rates — 2026-27 vs 2025-26
Any dividend income above the £500 allowance is taxed at the rates below. Basic and higher rates rose 2pp on 6 April 2026 (Autumn Budget 2025); the additional rate is unchanged:
| Rate band | 2025-26 | 2026-27 |
|---|---|---|
| Basic rate (income up to £50,270) | 8.75% | 10.75% |
| Higher rate (£50,271 – £125,140) | 33.75% | 35.75% |
| Additional rate (over £125,140) | 39.35% |
These rates apply to dividend income received from UK and overseas companies, including dividends from funds held outside an ISA.
Dividends within an ISA or pension are completely tax-free.
Impact on Individual Investors
For investors holding shares or equity funds in a General Investment Account (GIA), the practical effect of the £500 allowance depends on the size of their portfolio and the dividend yield.
Example: A Mid-Sized Investment Portfolio
An investor holds £60,000 in a diversified equity portfolio in a GIA. The portfolio yields approximately 3% in dividends — around £1,800 per year.
- Dividend allowance: £500
- Taxable dividend: £1,300
- If a higher rate taxpayer: 33.75% × £1,300 = £438.75 additional tax per year
In 2022-23, the same investor’s £1,800 dividend income would have been entirely covered by the £2,000 allowance. They would have paid nothing. Now they owe £438.75 — purely due to the allowance reduction.
Over a decade, assuming similar dividends and tax treatment, the accumulated extra tax is significant.
Impact on Company Directors
Limited company directors who pay themselves through a combination of salary and dividends are among the most affected by the allowance reduction.
Why the Salary/Dividend Structure?
Many small company directors structure their remuneration to minimise total tax. The typical approach:
- Pay a salary up to the National Insurance secondary threshold (£5,000 in 2025-26, or slightly higher to maintain an NI qualifying year) — this is deductible from corporation tax with no NI cost for the director
- Take remaining income as dividends from retained profits after corporation tax
Dividends are taxed at lower rates than salary, but the combination of corporation tax already paid on the profit and then dividend tax on the distribution means the effective rate can be higher than it appears.
How the Allowance Reduction Affects Directors
For a director taking, say, £50,000 of total income (salary of £12,570 + dividends of £37,430), the reduction in the allowance means:
| Tax year | Taxable dividend | Dividend tax (basic rate) |
|---|---|---|
| 2022-23 | £35,430 (after £2,000 allowance) | £3,100 |
| 2025-26 | £36,930 (after £500 allowance) | £3,231 |
The difference is modest at these income levels. But for a director who is a higher rate dividend taxpayer (dividend income pushing total income above £50,270), the higher 33.75% rate applies to the extra amount no longer covered by the allowance.
Optimal Salary/Dividend Split in 2025-26
There is no single “optimal” salary level for all directors, as it depends on whether the director has Employment Allowance available, whether there are other employees, and the individual’s other income. However, common strategies for a sole director/employee in 2025-26:
Option 1: Salary at £5,000 (secondary threshold)
- No employee or employer NI
- Salary is deductible from corporation tax
- You do not need to formally register for PAYE if salary is below the lower earnings limit, but you lose NI qualifying year entitlement
Option 2: Salary at £12,570 (personal allowance)
- No income tax on salary
- Employee NI applies on earnings above £12,570 — but salary is exactly at the threshold, so no employee NI
- Employer NI applies on earnings above £5,000: 15% × £7,570 = £1,135.50 employer NI
- Salary is deductible from corporation tax (saving 25% CT on the salary amount)
- Whether the NI cost is worthwhile depends on whether the corporation tax saving exceeds the employer NI — at 25% CT and 15% employer NI rates, it broadly does if you have the Employment Allowance, but may not if you’re a sole director without it
Option 3: Salary between £6,240 and £12,570
- Earns an NI qualifying year (protecting state pension entitlement) without necessarily triggering employer NI above the allowance
- Some directors use a salary just above the lower earnings limit (£6,240 in 2025-26) to secure their NI qualifying year at minimal tax cost
After taking a salary, remaining income can be distributed as dividends from post-corporation-tax profits. The first £500 of dividends is tax-free; the rest is taxed at 8.75% (basic rate) or 33.75% (higher rate).
Always consult an accountant when deciding your salary/dividend split — individual circumstances vary significantly and the rules change frequently.
Strategies to Reduce Dividend Tax
1. Use Your ISA Allowance
The most effective way to shelter dividend income from tax is to hold dividend-paying shares and funds inside a Stocks and Shares ISA. Dividends within an ISA are completely free of tax — the £500 allowance does not even apply.
With a £20,000 annual ISA allowance, a couple can move £40,000 of investments into ISAs each year. Any dividends on those ISA holdings are tax-free going forward.
2. Bed and ISA
If you have holdings in a GIA generating taxable dividends, consider a “Bed and ISA”: sell the investment in the GIA and repurchase it inside an ISA. Future dividends will then be tax-free. Note that the sale crystallises any capital gain, so consider the CGT impact alongside the £3,000 CGT annual exemption.
3. Pension Contributions for Directors
Company directors can make employer pension contributions directly from the company. These are:
- Deductible from corporation tax as a business expense
- Free of employer NI
- Free of personal income tax (as they are not personal contributions but employer contributions)
- Unlimited by the personal allowance rule (though the annual allowance still applies)
For higher-earning directors who would otherwise take large dividends taxed at 33.75%, making employer pension contributions instead can be much more tax-efficient.
4. Spouse Shareholding
If your spouse or civil partner is a lower-rate taxpayer or has unused personal allowance and dividend allowance, consider whether they could hold a shareholding in the company. Dividends paid to a lower-rate shareholder may attract a lower dividend tax rate. This arrangement must reflect commercial reality and genuine shareholding — purely artificial arrangements to avoid tax can be challenged by HMRC under the settlements legislation.
5. Retain Profits Rather Than Distribute
If you do not need the cash immediately, retaining profits in the company rather than distributing them as dividends defers the dividend tax. Retained profits can be invested within the company or distributed more tax-efficiently in future years, for example when you have used up carry forward pension allowances or when you retire and have lower income.
Use our dividend tax calculator to calculate the exact dividend tax owed for 2025-26 based on your income and dividend amounts.