Pension contributions vs dividends – The battle to build wealth for business owners
Andrew Tricker, 27 October 2025
Andrew Tricker, 27 October 2025
As the current 2025/26 tax year progresses, many SME owners face a familiar question: what is the most efficient way to take profits from my company?
For years, dividends were the go-to option, however, with Corporation Tax now at 25 per cent, the dividend allowance cut to just £500 and the lifetime allowance on pensions abolished and replaced with a more generous allowance, employer pension contributions look more compelling than ever.
Dividends are attractive because they avoid National Insurance and are taxed at lower rates than salary:
They can be declared as final dividends at year end or as interim dividends during the year, giving flexibility throughout the year to withdraw profits as a lump sum.
However, they are paid after Corporation Tax. The timing can also affect personal tax liabilities and dividends can only be paid when distributable profits exist.
They are useful in periods of strong profitability but less reliable as a guaranteed income stream.
Employer pension contributions are an allowable business expense, reducing profits before Corporation Tax.
Unlike salaries, there are no National Insurance costs and unlike dividends, there is no need for distributable profits to receive them.
With an annual allowance of £60,000 (tapering from £260,000 adjusted income, minimum £10,000) and the lifetime allowance abolished, the pension option has become more attractive.
Contributions benefit from tax relief and funds grow free from Income Tax and Capital Gains Tax until retirement.
Directors can usually access pensions flexibly from age 55, rising to 57 in 2028, with 25 per cent normally tax-free.
This is why they are becoming an increasingly popular vehicle for distributing profits from a company as part of a wealth plan.
Using 2025/26 rates for a higher-rate taxpayer:
*Assumes the dividend allowance has already been used.
Even after tax on withdrawal, the pension compares strongly. Taken as a basic-rate taxpayer, £8,500 net is available, or £7,000 as a higher-rate taxpayer.
This is 67 per cent and 37 per cent more than a bonus and 71 per cent and 41 per cent more than a dividend payment.
Short-term efficiency matters, but the real advantage of pensions emerges over time.
The pension strategy delivers almost 60 per cent more wealth after a decade, highlighting the power of compounding within a pension pot.
** Assumes dividend rates don’t change during this period.
Wealth transfer and future challenges
Pensions have also been powerful estate planning tools, typically free from inheritance tax (IHT).
However, from 2027, unspent pensions will count towards estates for IHT purposes. This could push more business owners towards using dividends to extract profits earlier and diversify wealth into ISAs or other structures.
Taking all of this into consideration, the optimal strategy is often a mix of pensions and dividends, but every individual’s set of circumstances is different, which is why it is important to obtain professional advice.
If you would like to know how you can incorporate your business profits into your wider life wealth planning, please get in touch with Director, Andrew Tricker (andrewtricker@lfwm.co.uk).
*This blog post has been written by Lubbock Fine Wealth Management (LFWM). The opinions and views expressed are those of LFWM and do not necessarily reflect
those of Lubbock Fine. All information provided in this blog is for informational purposes only and should not be considered professional advice. LFWM is not
responsible for any actions taken based on the content of this blog.
