If you’re running a limited company like I am, and you’re using dividends as a key part of your income strategy, you’ve probably had this on your radar for a while: the dividend allowance is being slashed again in the 2025/26 tax year. Yep, the government’s been tightening the screws on small business owners and contractors, and this latest move makes it even more important to plan how you pay yourself.
When I started contracting, dividends were the golden goose, lower tax, flexible payments, and a lot less admin than salary. But each year, it feels like the benefits are getting squeezed, and 2025/26 is no different. So let’s break down what this new allowance looks like, how it affects you, and whether dividends are still worth it at all.
What Is the Dividend Allowance? A Quick Refresher
Before we get into the new numbers, let’s do a quick refresher. The dividend allowance is the amount of dividend income you can receive each year tax-free, on top of your personal allowance. It was introduced back in 2016, and let me tell you, it used to be a whole lot more generous.
Back in the day, we were talking £5,000 of tax-free dividend income. Then it dropped to £2,000, then £1,000, and now, well… it’s heading further south. As a limited company director, you probably take a small salary and top up with dividends. That strategy still works, but only if you know the rules and plan around them.
The 2025/26 Dividend Allowance: What’s the New Limit?
Alright, here’s the headline: the tax-free dividend allowance for the 2025/26 tax year is just £500. That’s right—five hundred pounds. Half of what it was in 2024/25. If you were hoping for a reversal or freeze, no such luck.
Let’s quickly compare recent years:
| Tax Year | Dividend Allowance |
|---|---|
| 2021/22 | £2,000 |
| 2022/23 | £2,000 |
| 2023/24 | £1,000 |
| 2024/25 | £1,000 |
| 2025/26 | £500 |
So, what’s the reasoning? In short, the government’s been trying to reduce the tax advantage that small business owners and investors have over employees. They’re pushing for “fairness,” but for those of us running lean, single-director companies, it just feels like another squeeze.
How This Impacts Contractors and Freelancers
Let’s get into the real-world impact, especially if you’re doing the classic low-salary, high-dividend structure.
If you used to take, say, £10,000 in dividends, you’d pay tax on £9,000 of that in 2024/25. Now, in 2025/26, you’ll pay tax on £9,500. Doesn’t sound massive? Well, let’s break it down:
Example:
- Salary: £12,570 (within your personal allowance)
- Dividends: £10,000
- Tax-free allowance (2024/25): £1,000
- Tax-free allowance (2025/26): £500
- Taxable dividend (2024/25): £9,000
- Taxable dividend (2025/26): £9,500
At the basic dividend tax rate of 8.75%, that’s an extra £43.75 in tax. Not life-changing, but add that across multiple years, and it adds up, especially if you’re drawing more substantial dividends or are in the higher tax bracket.
For higher earners (those earning above £50,270), the tax bite is even bigger because higher rate dividend tax is 33.75%. That same £500 now costs you £168.75 in extra tax.
Dividend Tax Rates for 2025/26
The tax rates on dividends haven’t changed in 2025/26, they’re still the same as last year, but they hit harder now that the allowance is lower:
- Basic rate (up to £50,270 total income): 8.75%
- Higher rate (income between £50,271 and £125,140): 33.75%
- Additional rate (over £125,140): 39.35%
The rates apply after you’ve used your personal allowance (£12,570) and the £500 dividend allowance.
Salary vs Dividends: What’s Still the Smartest Strategy?
Even with the reduced allowance, the classic approach of a small salary + dividends still works, but now you need to be more precise.
Most contractors pay themselves a salary just above the NI threshold (currently £12,570), which avoids income tax but keeps you eligible for state pension and other benefits. Then you take the rest as dividends. This structure still gives you the best overall tax efficiency, but the margin of benefit is shrinking.
If you’re earning over £50,000, you really need to look at your numbers and talk to your accountant. You might find it more beneficial to leave profits in the company or reinvest them.
What Counts as a Dividend Anyway?
Dividends can only be paid out of retained profits, that is, money left over after paying all business expenses and Corporation Tax. You can’t just draw out funds whenever you want and call it a dividend.
Plus, dividends must be properly declared, with board meeting minutes and dividend vouchers, even if you’re the only director and shareholder. If HMRC audits you and you haven’t done it right, you could face reclassification of those payments as salary, and that means back taxes, interest, and penalties.
Do You Still Need an Accountant?
Absolutely—now more than ever.
With the dividend allowance shrinking, HMRC’s appetite for detail growing, and IR35 still hovering over the heads of contractors like a grey cloud, having a solid accountant is not just a luxury. It’s a necessity.
Your accountant doesn’t just run numbers. They ensure your dividend payments are properly declared with all the required paperwork. That includes creating dividend vouchers, board meeting minutes, and ensuring dividends come only from retained profits, something you can’t fake if your books are tight.
I’ve heard stories of solo contractors who decided to DIY everything to save money, only to find themselves slapped with unexpected tax bills, fines, and even investigations because they didn’t keep the right records. Trust me, that £80–£100 per month you pay your accountant can save you thousands down the line.
Plus, a good contractor-savvy accountant will help you plan your salary/dividend mix, calculate optimal tax strategies, advise on pension contributions, and tell you when to hold off on drawing more cash to avoid crossing tax thresholds.
Can You Still Make Dividends Work in Your Favour?
Despite the reduced allowance, dividends still have their place. They’re taxed at a lower rate than salary, don’t incur National Insurance, and they give you more flexibility in how and when you pay yourself.
So yes, you can still make them work, but you need to be smarter.
Start by thinking longer term. Could you reduce your dividend withdrawals and leave profits in the company this year, saving them for a future tax year when your income is lower? That’s something my accountant and I look at every year.
Another smart play is investing in a pension. Employer contributions made from your company are a legitimate business expense, so they reduce your Corporation Tax while building your future savings tax-free.
And don’t overlook your ISA allowance. Dividends earned from shares inside an ISA are completely tax-free. It’s not the same as company profits, but if you invest personally, it’s a way to keep more of your passive income.
What About Married Couples or Family Members?
If you’re married or in a civil partnership and your spouse is in a lower tax band, or not using their dividend allowance, you could consider making them a shareholder in your company. That way, you can split dividends between the two of you and take advantage of two sets of tax allowances.
This strategy is known as income splitting, and it’s completely legal, if done properly. The key is making sure they actually own the shares and receive the dividends. HMRC has cracked down on arrangements that are purely artificial, so don’t try to cut corners here.
I added my partner as a shareholder a couple of years ago, and it’s been a great move. We now get double the dividend allowance (even if it’s just £500 each in 2025/26), and more importantly, we distribute income in a way that keeps us both under the higher tax threshold.
IR35 and Dividends: A Dangerous Mix?
Here’s where things get tricky. If you’re caught by IR35, you can’t pay yourself dividends from your contract income, at least not in the traditional way. All payments must be processed through PAYE, with full Income Tax and National Insurance applied. That pretty much erases the benefit of dividends entirely.
If you’re working in the public sector, or for large clients in the private sector, they’re the ones who determine your IR35 status. But if you work with smaller clients, it’s still up to you. That’s where the risk lies.
Get it wrong, and you could owe years of back taxes, plus penalties and interest. It’s worth paying for an IR35 contract review, especially if you plan on taking dividends. I do this every time I start a new engagement. It costs me about £100, but it’s worth it for the peace of mind.
So yes, dividends are great, but only if you’re outside IR35. If you’re inside? Forget about it. Your best bet is to go umbrella or restructure entirely.
Dividend Changes and the Future of Contracting
The writing’s on the wall: dividends are no longer the golden ticket they once were. The £500 allowance in 2025/26 is the smallest we’ve ever seen, and there’s no guarantee it won’t vanish completely in future Budgets.
That doesn’t mean limited companies are dead. There are still benefits, like limited liability, flexible income, and potential tax savings, but you need to be proactive. The days of “set it and forget it” are long gone.
Contractors now need to rethink their financial strategies every tax year, watch for Budget announcements like hawks, and stay close to their accountants.
Me? I’m not giving up on my limited company anytime soon. But I’m keeping a closer eye on every pound that comes in and goes out—and thinking much more carefully about how, when, and why I pay myself dividends.
FAQs: All About Dividend Allowance 2025/26
1. How much is the dividend allowance in 2025/26?
It’s £500, reduced from £1,000 in the previous year.
2. Is the dividend allowance on top of the personal allowance?
Yes. You still get the standard £12,570 personal allowance, and the £500 is in addition to that—specifically for dividend income.
3. Do I have to pay tax on dividends over £500?
Yes. Dividends over the allowance are taxed at 8.75%, 33.75%, or 39.35% depending on your income band.
4. Can I take dividends if I’m inside IR35?
No. IR35 rules require all income to be taxed under PAYE, so dividends are off the table.
5. Can I split dividends with my spouse?
Yes, if they are a shareholder. It’s a legal and common strategy for income splitting.
6. Is it still worth taking dividends in 2025/26?
Yes, but the benefits are smaller. It still beats salary for most people below the higher tax band—just make sure it’s done properly.
Time to Rethink How You Pay Yourself?
If you’re a contractor running your own limited company, the 2025/26 dividend allowance cut is just another curveball in what’s become a fairly relentless game of tax Tetris.
Yes, it’s frustrating. Yes, it eats into your take-home pay. But with a bit of planning, some good advice, and a flexible approach to your finances, you can still make the limited company model work for you.
My advice? Stay informed. Review your pay structure annually. Talk to your accountant. And don’t make knee-jerk decisions based on headline tax changes. Because in the world of contracting, agility is your biggest asset.