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Under shelter

02 March 2018

Changes to dividend taxation in April make it even more important that investors make full use of tax-efficient shelters to create and protect wealth.

When he introduced it in April 2016, it’s doubtful that then-chancellor George Osborne anticipated his new Dividend Allowance would be so short-lived.

The allowance was introduced to encourage people to invest by making the first £5,000 of dividend income earned by shareholders each year tax-free. At the time, the government claimed the new allowance would reduce the tax bill for one million people.1

But in March last year, as part of a wide-ranging attack on the self-employed, his successor, Philip Hammond, announced plans to cut the tax-free dividend allowance to £2,000, as of 6 April this year.

There were hopes that the allowance would remain unchanged after the proposal was omitted from the Finance Bill last May. However, the government subsequently confirmed its intention to cut it.

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 top earners.

The biggest losers will be business owners who pay themselves dividends as a more tax-efficient alternative to salary. The measure, like the proposed increase to Class 4 National Insurance (which was subsequently scrapped) was designed to level the playing field between the employed and self-employed.

However, it will also leave some private investors worse off. That includes, perhaps unintentionally, those who are using dividends to help fund their retirement. Many could be pensioners who turned to investing in equities because interest rates were so low.

That raises the question: what can investors do to minimise their dividend tax liability?

Take shelter

“Making the maximum possible use of tax-efficient wrappers is a basic step, but the best line of defence against this tax change,” says Tony Müdd, divisional director at St. James’s Place. “Investors with substantial holdings outside of ISAs and pensions should consider moving them into these tax shelters. This could produce capital gains, though, so such a move will need to be managed within the CGT allowance of £11,300.”

Assuming a dividend yield of 3.5%, those investors with portfolios worth around £50,000 held outside of these wrappers should still pay no tax on the income generated. As a result, a couple could still hold a significant sum in non-ISA and pension investments, without that sum being subjected to dividend tax.

But there is no doubt that building up funds within ISAs and pensions is the surest way to minimise tax liabilities, and to mitigate the impact of further tax changes.

Making the maximum possible use of this year’s ISA allowance of £20,000 is an obvious starting point; but taking advantage of other tax allowances and exemptions can also make a big difference.

  • The personal tax allowance of £11,500 can also cover dividend income, if other income sources add up to less than that amount.
  • Assets can be passed between spouses without restriction, which enables full use of both partners’ personal allowance, CGT allowance and reduced dividend allowance.
  • It might be possible to generate income as interest rather than as dividends; for example, from bond funds, which might then fall within the tax-free Personal Savings Allowance for interest payments.

The dividend allowance cut illustrates the capacity for tax rules to change regularly.

“This change underlines the importance of reviewing your personal finances on a regular basis, to ensure that they are arranged as tax-efficiently as possible,” says Müdd. “The end of the tax year presents an ideal and, in some cases, final opportunity to check that you are making the best possible use of exemptions and allowances.”

 

The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances. 

¹ HMRC, July 2015

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