April 2016 will bring about changes to how dividends are taxed.
Dividends are annual cash payments made to holders of certain shares, which provide a vital source of income to many pensioners that rely on savings in retirement – many pick shares solely based on their dividend payouts. With the new system the current Dividend Tax Credit will be replaced by a new tax-free Dividend Allowance. The allowance is available to anyone who has dividend income and means that a person does not have to pay tax on the first £5,000 of dividend income regardless of other non-dividend income.
Currently those paying basic-rate tax are not required to pay tax on dividends, however from April 2016 basic-rate taxpayers will be subject to a new levy of up to 7.5%. This will mean that an additional £2.5 billion will be cut out of investors’ income through tax.
Under the proposed new system all taxpayers will have a new tax-free dividend allowance of £5,000 per year. A person’s income tax rate band decides the overall tax rate – 7.5% within the basic rate, 32.5% within the higher rate and 38.1% within the additional rate band. If the dividend income pushes a person from one income tax band into the next, they will then pay the higher dividend rate on that portion of income.
Chartered financial planner Danny Cox from Hargreaves Lansdown said, that the new dividend taxation rules are definitely simpler, yet they are also costly for some. Investors now need to navigate very carefully around the new rules to avoid tax rises. To avoid this, he also said that people should use their tax shelters such as ISAs even if they believe their income or gains will currently fall within tax-free allowances.
Ways to beat dividend tax rises:
• use the ISA allowance now – as unlimited dividends can be drawn from an ISA tax-free, sheltering taxable investments in ISA accounts will become more important
• consider a SIPP (Self-Invested Personal Pensions) – also carry the benefit of tax-free dividends; a good option for retirement savings where money is not needed until age 55
• maximise the annual tax-free dividend allowance – married couples and registered civil partners should spread their taxable portfolios between each other; this also applies to personal allowances and basic rate tax bands to enable taxable dividends to be paid in the name of the spouse with the lowest tax rates
• be clever with yield – shelter shares and funds that generate the highest yields in an ISA to maximise dividend income tax allowance
• reduce other income to move down a tax band – if possible transfer income bearing assets to a lower earning spouse
• invest in Venture Capital Trusts – these create tax-free dividends in addition to an ISA and £5,000 Dividend Allowance, where a sophisticated investor is happy to take higher risks
