Investing your wealth can be an effective way to achieve long-term growth and it may be a good way to protect your savings during periods of high inflation too.
If you invest in equities (that is, stocks and shares), you may receive dividends. A dividend is the distribution of a company’s earnings to its shareholders and is determined by the company’s board of directors. Dividends are often distributed quarterly and may be paid out as cash or in the form of reinvestment in additional stock. If the business you invest in performs well, you could receive a higher dividend payment and the value of the stocks or shares themselves may increase too.
These dividends can be incredibly beneficial because you can use them to generate an income. Alternatively, you can reinvest them and use them to purchase more shares, so your wealth continues growing at a faster rate.
That said, it’s important to consider the tax you may pay on any dividends you receive as this could affect the profits you make from your investments.
Unfortunately, the number of people set to pay Dividend Tax – the tax you may have to pay on any dividends you receive from stocks and shares – is likely to increase due to changes to the Dividend Allowance.
The Dividend Allowance is set to drop to £500 in April 2024
The Dividend Allowance is the amount you can earn each year from dividends without paying tax.
The threshold was previously frozen at £2,000 before the government reduced it to £1,000 in the 2023 spring Budget. As a result, more people are likely to exceed their allowance and pay tax on their dividends in the 2023/24 financial year.
The government also plans to reduce the Dividend Allowance again to £500 in April 2024, meaning even more people will pay Dividend Tax for the first time. So, it’s important to be aware of what you may have to pay.
You may have to pay tax on any income from dividends that exceeds your Dividend Allowance. For example, if you receive £5,000 in the 2023/24 financial year, your Dividend Allowance is £1,000, meaning you might face a tax bill on the remaining £4,000.
The rate of Dividend Tax that you pay depends on your marginal rate of Income Tax. You’ll pay:
- 75% if you are a basic-rate taxpayer
- 75% if you are a higher-rate taxpayer
- 35% if you are an additional-rate taxpayer.
This means that, in the 2023/24 tax year when the Dividend Allowance is £1,000, a higher-rate taxpayer earning £5,000 a year from dividends in a general investment account (GIA) would pay £1,350 in Dividend Tax.
The following tax year, when the Dividend Allowance drops to £500, the same person would pay £1,518.75.
According to Professional Paraplanner, an additional 1.8 million people could be paying the tax by the end of the 2024/25 financial year as a result of reductions to the Dividend Allowance.
This means that you may have to pay Dividend Tax for the first time soon. Fortunately, there are ways to potentially mitigate this if you plan ahead.
Three effective ways to reduce Dividend Tax
- Use your full ISA allowance
A Stocks and Shares ISA is an effective vehicle for reducing tax because you do not pay Income Tax, Capital Gains Tax (CGT) or Dividend Tax on any investments held in this type of “tax wrapper”.
You can contribute up to £20,000 across all your ISAs each tax year, and making full use of this allowance before investing in a taxable GIA could reduce the amount of Dividend Tax that you pay.
Bear in mind that if you want to move investments outside an ISA into a Stocks and Shares ISA, this involves selling them and buying them back. Depending on the value of the investment, this could trigger a CGT charge.
As such, it may be worth seeking advice before doing this so you can find the most tax-efficient way to handle your investments.
- Invest more in your pension
Dividends paid by investments in a pension are also tax-free. So, if you have already exceeded your Dividend Allowance, or you are likely to in the future, you may want to consider increasing pension contributions instead of purchasing more shares.
As well as helping you reduce Dividend Tax, you also benefit from tax relief on your pension contributions.
Just be aware that your Annual Allowance – the amount you can accumulate in your pension while still receiving tax relief – is £60,000 (or 100% of your earnings, whichever is lowest) in the 2023/24 financial year. Your Annual Allowance may be lower than this if you are a high earner or have flexibly accessed your pension.
If your total contributions, including tax relief and employer contributions, exceed this, you may have to pay Income Tax on anything above the Annual Allowance.
In this case, you may need to consider whether making additional pension contributions is the most tax-efficient option.
Additionally, you won’t be able to access any funds you pay in until you start drawing from your pension and currently, you must wait until you are at least 55 years old (57 from 2028 onwards) – to do this. So, if you are currently relying on the dividends from your investments as a source of income, increasing pension contributions may not be the best choice.
- Share investments with your spouse
Your spouse also has their own Dividend Allowance, so joint planning could help you both pay less tax.
You can normally transfer assets to your spouse without paying CGT on them. If one of you has not used up your Dividend Allowance, you can take advantage of this and share your investments between you. This means you can make full use of both of your Dividend Allowances.
That said, if you pass an asset to your spouse and they later come to sell it, they may still pay CGT on it. The rules surrounding this can be complicated, so it may be useful to seek advice before selling any investments to ensure you do not get a surprise tax bill.
Get in touch
A large Dividend Tax bill could eat into any profits from your investments. Fortunately, we can help you find more tax-efficient ways to hold your wealth.
Email hello@fcadvice.co.uk or call 0330 828 4714 for more information.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term (minimum of 5 years) and should fit in with your overall risk profile and financial circumstances.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
The Financial Conduct Authority does not regulate tax planning.
