George Osborne revealed a shake-up in the way dividend income is taxed In the summer Budget yesterday.
All taxpayers will have a tax-free dividend allowance of £5,000 a year – which makes life better for many small investors seeking income from their shareholding.
After this, the rate of tax payable on dividends will depend on taxable income. If your dividend income takes you from one income tax band into the next, you will then pay the higher dividend rate on that portion of income.
The Chancellor has made the move to encourage small investors to invest – but a new tax rate that will increase to a maximum of 38.1 per cent will hit wealthier small investors, large-scale investors and chief executives with share options.
Dividend tax: The Chancellor announced changes in the way dividends are taxed in the summer Budget yesterday
It is possible that retail investors who have built up sizeable portfolios could be subject to the higher rate. For example, a stocks portfolio of £125,000 with a yield of 4 per cent will generate £5,000 income a year and use up the dividend allowance.
A portfolio of £500,000 yielding one per cent generates the same £5,000 a year.
Investing expert Danny Cox from Hargreaves Lansdown gives ten tips to save dividend tax rises.
1. Maximise your annual tax-free dividend allowance
Each person will be entitled to a new tax-free Dividend Allowance of £5,000 per annum. Married couples (and registered civil partners) should spread their taxable portfolios between them to make full use of each person’s allowance.
2. Make the most of each spouse’s income tax allowance and tax bands
Married couples should make full use of personal allowances and basic rate tax bands, where applicable, so that taxable dividends are paid in the name of the spouse who pays the lowest tax rates.
3. Use an Isa
Taxpayers will see a tax increase of 7.5 per cent on dividend income received above £5,000 a year.
This makes sheltering taxable investments in an Isa all the more important as unlimited dividends can be withdrawn from an Isa tax-free.
There is also no capital gains tax to pay in an Isa. £15,240 worth of existing investments can be sheltered in an Isa in this tax year.
4. Use a Sipp
Sipps also have the benefit of tax free dividends. For retirement savings where money is not needed until age 55 the tax benefits of Sippss are highly compelling.
Most people can invest up to 100 per cent of earnings effectively capped at £40,000 in this tax year and receive tax relief up to 45 per cent.
5. Be clever with yield
It’s good practice to use your Isa allowance. However where you have already done so, be clever with yield.
A diverse portfolio will have shares and funds which generate different levels of dividend income yield. Shelter those which generate the higher yields in an Isa to maximise the dividend income tax allowance.
For example, a taxable portfolio of £125,000 with a yield of four per cent will generate £5,000 a year and use up the dividend allowance. However a portfolio of £500,000 yielding one per cent generates the same £5,000 a year. Shelter higher yielding funds and shares in Isa.
|2015/2016 tax year||Net dividend||Tax credit||Additional tax||Dividends after all tax|
|Basic rate taxpayer||£1,000||£111||£-||£1,000|
|Higher rate taxpayer||£1,000||£111||£250||£750|
|Additional rate taxpayer||£1,000||£111||£306||£694|
|2016/2017 tax year|
|Annual tax-free Dividend Allowance||£5,000|
|Dividends in excess of Dividend Allowance|
|Gross dividend||Tax credit||Tax due||Dividends after all tax|
|Basic rate taxpayer||£1,000||£-||£75||£925|
|Higher rate taxpayer||£1,000||£-||£325||£675|
|Additional rate taxpayer||£1,000||£-||£381||£619|
6. Use the new personal savings allowance for corporate bonds
In most cases, the income from fixed interest funds and corporate bonds is subject to interest tax, not dividend tax.
From April 2016, the first £1,000 of interest income from these holdings will be free of income tax under the new personal savings allowance (£500 for higher rate taxpayers). This provides the opportunity for tax-free income in addition to the dividend allowance and Isa income.
It’s important to note that the personal savings allowance also applies to taxable cash interest, so it’s important to ensure you don’t exceed £1,000 a year (£500 for higher rate taxpayers).
7. Reduce other income
After the new dividend allowance, dividend tax is linked to the rate of income tax you pay. Therefore reducing your other taxable income could also reduce the amount of dividend tax paid.
In some cases taxable income for a particular year could be reduced – perhaps by transferring income bearing assets such as cash deposits to a lower earning spouse, or deferring withdrawals from a drawdown pension until a new tax year.
8. Use pension to save dividend tax
A pension contribution can also be used to reduce dividend tax liabilities for many investors by taking advantage of the tax relief on the contribution.
Effectively the basic rate tax band is increased by the amount of the pension contribution, meaning larger gains might be realised before the higher rate of dividend tax is payable.
For example, a pension contribution of £3,600 will extend the basic rate tax band from £43,000 to £46,600 (2016/17 tax year). Then, providing other taxable income and taxable dividend income total less than £44,600 in this tax year, the dividend tax will be paid at 7.5 per cent and none at 32.5 per cent.
9. Invest in VCTs
For taxpaying, sophisticated investors, happy to take higher risks, Venture Capital Trusts generate tax-free dividends.
These tax-free dividends will be payable in addition to tax-free dividends from an ISA and tax-free dividends within the new £5,000 Dividend Allowance.
10. Defer taxation using an offshore investment bond
Dividend income within an offshore investment bond grows almost free of taxation (there may be a small amount of withholding tax). Investors only pay tax when profits are withdrawn.
Furthermore withdrawals of up to 5 per cent of the original capital a year can be taken without immediate tax charge.
Dividend income can therefore be deferred and timed to when lower rates of tax might be paid. For example, a higher rate taxpayer will pay 32.5 per cent dividend tax after the dividend allowance, whereas if deferred until the investor is a basic rate taxpayer, withdrawals from an offshore investment bond would be taxed at 20 per cent.
DIVIDEND TAX RATES
Non-taxpayers 0% 0%
Basic rate taxpayer 0% 7.5%
Higher rate taxpayers 25% 32.5%
Additional rate taxpayers 30.6% 38.1%