Dividends are convenient. But pensions are more tax-efficient, especially with dividend rates rising in April 2026. This guide shows you how to use pension contributions to extract profit from your company while paying less tax.
Quick Summary: Why Pensions Beat Dividends
Why Pensions Beat Dividends (Especially From April 2026)
Dividends are paid from profits that have already been taxed at the corporation tax rate (19% to 25%). You then pay personal dividend tax on top. That's double taxation.
Employer pension contributions come off your profits before corporation tax. There's no employer NI. There's no personal income tax at the point of contribution. The money goes straight into your pension.
Dividend Route (From April 2026)
£40,000 profit to extract as dividends:
Pension Route
£40,000 profit to pension:
The Trade-Off
You can't access pension money until age 55 (rising to 57 from 2028). If you need the money now, dividends are your only realistic option. But for long-term wealth building, pensions are significantly more efficient.
Employer Contributions vs Personal Contributions
There are two ways to get money into your pension. Employer contributions (from your company) and personal contributions (from your salary or savings). For most directors, employer contributions are the right choice.
Employer Contributions ✓
- Paid directly by your company
- Deductible against corporation tax
- No NI payable (employer or employee)
- No earnings limit (within reason)
Almost always the better option for directors
Personal Contributions
- Paid from your personal account
- Limited to 100% of UK earnings
- Tax relief via self-assessment
- Salary counts, dividends don't
Only useful if high income outside company
Annual Allowance and Carry Forward
The standard annual allowance for pension contributions is £60,000 for 2025/26. This includes both employer and personal contributions. But you can contribute more using carry forward.
| Tax Year | Annual Allowance | Notes |
|---|---|---|
| 2025/26 | £60,000 | Current year |
| 2024/25 | £60,000 | Carry forward available |
| 2023/24 | £60,000 | Carry forward available |
| 2022/23 | £40,000 | Carry forward available (last year) |
Carry Forward Explained
If you didn't use your full allowance in the previous 3 tax years, you can use that unused allowance now. This means some directors can contribute £180,000 or more in a single year. You must use the earliest year's allowance first.
High Earners: Tapered Allowance
If your adjusted income exceeds £260,000, your annual allowance is reduced. For every £2 above this threshold, your allowance drops by £1, down to a minimum of £10,000.
Money Purchase Annual Allowance (MPAA)
If you've already flexibly accessed a pension, your annual allowance drops to £10,000. This catches out directors who took pension freedoms early.
Worked Example: £40,000 Pension vs Dividends
Let's compare extracting £40,000 as dividends versus employer pension contributions. This assumes you're a higher rate taxpayer after April 2026.
| Factor | Dividend Route | Pension Route |
|---|---|---|
| Company profit needed | £53,333 | £40,000 |
| Corporation tax (25%) | £13,333 | £0 |
| Dividend / pension contribution | £40,000 | £40,000 |
| Personal tax (35.75% dividend) | £14,300 | £0 |
| Total tax paid | £27,633 | £0 |
| Value received | £25,700 cash | £40,000 pension |
At Retirement
When you access your pension, the first 25% (£10,000) is tax-free. The remaining £30,000 is taxed as income. If you draw it in retirement when your income is lower, you may pay only basic rate tax or less. Even then, the pension route wins.
When to Contribute: Timing Matters
The timing of pension contributions affects when you get tax relief.
Timing Checklist
- For corporation tax relief: Contribution must be paid before your company's year end
- For personal tax relief: Contribution must be made in the tax year you want to claim (6 April to 5 April)
- Allow buffer time: Plan contribution at least a month before year end for transfers to clear
HMRC's "Wholly and Exclusively" Test
Employer pension contributions must be made for the purpose of the trade. HMRC can challenge contributions they consider excessive.
What's Considered Reasonable
For most directors taking a reasonable salary (£40,000 to £80,000), contributing up to the annual allowance is unlikely to be challenged. The contribution looks like a normal part of a remuneration package. Large lump sums (£100,000+) may need documentation showing commercial justification.
Pension vs Salary vs Dividends: Complete Comparison
| Method | Corp Tax Relief | NI Payable | Personal Tax | Access |
|---|---|---|---|---|
| Salary | Yes | Both (15% + 8%) | 20% to 45% | Immediate |
| Dividends | No | None | 8.75% to 39.35% | Immediate |
| Pension | Yes | None | None (now) | Age 55/57 |
Frequently Asked Questions
Can I contribute more than £60,000?
Yes, using carry forward. If you have unused allowance from the previous 3 tax years, you can use it now. Some directors can contribute £180,000+ in a single year. Check your pension statements to see how much allowance you've already used.
Do dividends count towards my annual allowance?
No. Personal pension contributions are limited to 100% of your relevant UK earnings, which means salary, not dividends. But employer contributions have no earnings limit, which is why they're better for directors taking low salaries.
Should I take salary or use the money for pensions?
Most directors should take a small salary (around £5,000 to £12,570 to use your personal allowance and NI thresholds), dividends for immediate needs, and maximise pension contributions for long-term wealth building.
What happens to my pension if I die?
Pensions are usually outside your estate for inheritance tax purposes. If you die before 75, your beneficiaries can inherit the pension tax-free. After 75, they pay income tax on withdrawals. This makes pensions attractive for wealth transfer.
Related Guides
Use our Director Salary Calculator to find the optimal salary and dividend split for your situation.
With dividend tax rates rising in April 2026, pensions become even more attractive. Read our guide to understand the full impact.
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