Tax changes on dividends for investors

Image of a grandparent with grandchildren possibly thinking about the tax changes to come in 2016 with the new Dividend Allowance.

Tax

MoneyPlus Features Team

17th November 2015 at 7:00am

A new tax-free Dividend Allowance of £5,000 a year is being introduced in April 2016 as part of a number of measures from the Government to encourage saving.

Announced in the summer 2015 Budget, the new allowance means you don’t have to pay tax on the first £5,000 of any dividend income no matter what other income you have. This is on top of any investments you have within an ISA, where all investment returns are free of tax.

It’s very good news for many smaller investors looking for income from the shares they hold which aren’t part of an ISA; but it’s also important to highlight that if your dividend income is above this figure, new tax rates will apply – and some of these have increased.

This simpler system will mean that only those with a high income from dividends will pay more tax than they do now.

The new dividend tax rates

From 6 April 2016, you’ll pay tax on any dividend income you receive over £5,000 at:

  • 7.5% within the basic rate band
  • 32.5% within the higher rate band
  • 38.1% within the additional rate band.

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 changes will encourage small investors but the new top tax rate of 38.1% will hit wealthier investors, large investors and those with share options.

Another impact is some people will now have to start doing tax returns when in the past they wouldn’t have.

It will also affect those company directors who take dividends instead of salary, although taking dividends may still be better than paying themselves a salary thanks to National Insurance savings.

How the new Dividend Allowance works

Here are a couple of examples from HMRC of how the new Dividend Allowance works:

You don’t need to pay any tax on dividends up to £5,000, no matter what other income you get. That first £5,000 is tax free under the new rules.

  1. You have a (non-dividend) income of £18,000, and receive dividends of £22,000 outside of an ISA.

Tax you need to pay on the £22,000 dividend income:

  • the Dividend Allowance covers the first £5,000
  • the remaining £17,000 of dividends to be taxed at the new basic rate of 7.5%. This would need to be done through a tax return.

Had your other non-dividend income been £30,000, the tax due on the £17,000 dividend income would be made up of 7.5% for the amount within the basic rate band and 32.5% on the balance.

  1. You receive dividends of £600 from shares invested in an ISA

As is the case now, no tax is due on dividend income within an ISA, whatever rate of tax you pay.

Shareholding directors

If you’re a company director who takes dividends instead of a salary, speak to your accountant or adviser to find out how you will be affected by the upcoming changes in the next tax year and what steps you can take to be as tax efficient as possible.

Taking dividends may still be a good option but there are other tax planning opportunities to explore such as paying into a pension that might reduce the amount of tax you pay.

You can find out more on Gov.uk which has a useful Dividend Allowance factsheet from HMRC.

Past performance is not a reliable indicator of future performance. The value of your investments can go up or down and may be worth less than you paid in.

Join the conversation

Join the conversation and follow us on twitter @StandardLifeUK and Facebook and let us know about any of the experiences you have had in the past with tax changes or any questions you have about the approaching changes to the Dividend Allowance.

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