How to beat the dividend tax hike

Investors are set to pay over £1billion more in tax from next month, as the Government cracks down on business owners and savers by hiking the dividend tax rate. 

Last autumn the Treasury announced plans to raise the dividend tax rate, in a move which will be felt by limited company small business owners who pay themselves in dividends.

However, a side effect of successive Chancellors repeatedly cracking down on entrepreneurs paying lower rates than income tax has been to hit investors who have accumulated wealth outside of an Isa or pension pot – many of whom are retired and rely this for some of their income.

They will also see the tax rate on payouts they receive above the annual £2,000 dividend allowance rise to 8.75 per cent for basic rate taxpayers and 33.75 per cent for higher rate taxpayers.

The tax hike of 1.25 percentage points is set to bring in £1.34billion for the Government in the next tax year. 

It will see rates rise to 8.75 per cent for basic-rate taxpayers, 33.75 per cent for higher rate taxpayers and 39.35 per cent for additional rate payers.

Until it was slashed to £2,000 in 2018, the tax-free dividend allowance was £5,000 per year.

The Government’s own estimates show that 40 per cent of people with dividend income outside an Isa will see a tax increase, and 70 per cent of that will be paid for by higher and additional-rate payers.

‘The Government is cracking down on wealthier investors who have significant wealth outside of Isa and pensions, as well as company directors who pay themselves through dividends,’ says AJ Bell’s Laura Suter.

‘The dividend tax regime has changed repeatedly over the past decade, and investors have been subject to more and more squeezes on their income that have left them with far higher tax bills.’

The tax hike is most likely to affect those investors who own shares outside an Isa or pension, or those that have historical wealth that they never got around to putting into an Isa.

‘While the Isa allowance now is a very generous £20,000 it hasn’t always been that way – just over 10 years ago it was £7,200 and only in 2017 did it leap to the current high limit,’ says Suter. 

‘This means it’s very possible that people would have built up other investments and, coupled with investment growth, could now have a sizeable pot outside an Isa.’

How can investors beat the tax increase? 

There are however some ways for investors to beat the tax hike, namely moving money into an Isa or pension.

‘By using this year’s Isa allowance, and immediately using next year’s at the start of the new tax year in April, you can shelter £40,000 from the taxman before the dividend hike bites,’ says Suter. 

Jason Hollands, managing director of Bestinvest adds: ‘If you haven’t yet used your Isa allowance, there is still time to sell some of your unwrapped dividend generating shares – or funds – and then repurchase them within an Isa where future dividends (and capital gains) will be tax-free. This is known as a ‘Bed and Isa’ transaction. 

‘It will take a few days to complete because the process involves selling an investment, the funds clearing and then making an investment, so don’t delay if you want to do this during the remaining weeks of the current tax year.

‘In doing this, take care to try and avoid exceeding your annual capital gains tax exemption (£12,300 of gains can be crystallised tax free before 5 April). 

‘Also, check that the timing of the sale won’t disqualify you from receiving an upcoming dividend too. The bottom line is that Bed and Isa – or Bed and Pension – is a great way to migrate all of your taxable investments into a tax free environment, so it is well worth exploring.’ 

He also suggests transferring all of the shares of funds held in a taxable environment if you are married or in a civil partnership.

‘This will enable you to make use of two sets of dividend allowance, or potentially utilise an additional Isa allowance to shelter the shares or funds from future tax. 

‘This is known as an ‘interspousal transfer’ and it is one of the most basic, but effective things a married couple can do to optimise the tax efficiency of their family finances.’

Another option for those who own large portfolios is to rebalance the holdings so that income generating stocks and funds are prioritised within an Isa while non-yielding growth funds or shares are held in tax-efficient accounts.

Hollands adds: ‘For investors with a strong desire for income and portfolios that go well beyond Isas and pensions, another option could be to consider Venture Capital Trusts as part of the overall mix. 

‘Dividends on VCT shares are tax-free and tend to be high because most VCTs use dividends as a means of distributing the gains made on successful exits of companies they have backed to investors. 

‘However, it is important to flag that VCTs are high risk investments, focused on early-stage, illiquid companies and therefore these won’t suit everyone and should only be considered as a modest part of an overall portfolio.’