As part of wide ranging attack on the self-employed, chancellor Philip Hammond last year announced plans to tinker with the dividend tax rules, cutting the dividend tax-free allowance from £5,000 to £2,000.
80% of investors are not expected to pay tax under the dividend regime, but the big losers will be business owners who have hitherto paid themselves dividends as a more tax-efficient alternative to a salary.
Small businesses with a couple of employees and individuals such as freelancers and contractors who run their own limited companies will therefore feel the pinch more than others. Those with non-ISA and pension investments above the £50,000 mark will also be negatively impacted by the smaller allowance.
Dividends above the £2,000 threshold will be taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers.
Make use of tax-efficient wrappers
Below, our sister website Money Observer runs through the various ways investors can minimise their dividend tax liability.
Investors with substantial holdings outside ISAs and pensions should consider moving them into a wrapper. The transfer, however, will involve selling and buying back shares, which could produce capital gains. The capital gains tax (CGT) allowance is £11,300.
To avoid the risk of a CGT bill, the process known as ‘bed and ISA’ or ‘bed and SIPP’ involves selling enough of your investment to realise gains up to the value of the CGT exemption and then buying them back within your ISA or SIPP, or that of your spouse.
However, you need to be aware that there may be transaction charges involved and there will be a period when your money isn’t invested.
The ISA allowance for the 2017-2018 tax year stands at £20,000, and will remain the same for the 2018-2019 tax year.
Source: Money Observer Past performance is not a guide to future performance
Best line of defence
By taking full advantage of tax-efficient wrappers, most investors will not be affected by the new dividend tax rules.
Bear in mind, however, that in the case of self-invested pensions dividends are tax-free within the wrapper – but when you come to draw on your pension pot, withdrawals that exceed the 25% tax-free allowance will be taxed as income.
Patrick Connolly, a financial planner at Chase de Vere, adds: “Tax rules change regularly, which is why your personal finances need to be reviewed on a regular basis, to ensure they are set up tax efficiently and in the best way to meet your goals.
“For many people taking basic steps like using tax-efficient wrappers and taking advantage of different tax allowances can make a big difference to their overall finances.”
Other ways to beat the dividend tax
- The personal allowance, which stands at £11,500, may also cover dividend income if your other income sources are worth less than that sum. The allowance will rise to £11,850 from the start of the new tax year.
- Assets can be passed between spouses without restriction, so make sure you make full use of both partners’ personal allowance.
- Specialised investment plans such as onshore and offshore bonds can be used to minimise the tax on dividend income. These plans allow investors to defer tax on payouts. But they are complex products and can be expensive, so seek guidance from a financial adviser.
- Gifting dividends to children is another tax-efficient option, if you are confident you won’t need the gifted money in future. But, again, it would be prudent to seek financial advice.
- See if some of your income can be generated as interest rather than dividends in order to benefit from the Personal Savings Allowance, which allows £1,000 to be held in cash before paying tax. Payouts from bond funds, for instance, count as interest.
- Explore whether you can reduce the level of natural dividend income by selecting funds with lower yields and more of a growth focus; make up any shortfall by taking capital withdrawals to utilise your capital gains tax allowance.
This piece was originally written in March 2017, and has subsequently been updated in March 2018 ahead of the dividend tax change coming into force.
This article was originally published in our sister magazine Money Observer. Click here to subscribe.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation, and is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.