Dividends have been an effective way of increasing tax efficiency for many years, not only because their rates are lower than Income Tax, but because they are not liable to National Insurance contributions (NICs).
So, when the government recently announced a 1.25 percentage point increase to Dividend Tax, company directors and investors were left facing a potential tax hike. According to the Guardian, the increase could generate an additional £600 million for the Treasury.
The rise in Dividend Tax was made alongside increases to NICs in September 2021, which rose by the same amount. Both increases are part of the government’s strategy to fund health and social care in England.
It’s not all bad news though. The government has left the Dividend Allowance of £2,000 unchanged in 2021/22, which allows you to earn this amount before you become liable to the tax.
So, what could the increase in Dividend Tax mean for you? Read on to learn three vital things you need to know.
1. Dividend Tax rates will increase after April 2022
As the table below shows, if you currently receive dividends, you will pay different rates depending on whether you are a basic-, higher- or additional-rate taxpayer.
|Dividend tax rate before April 2022||Dividend tax rate after April 2022|
As the Dividend Allowance remains at £2,000 in 2021/22, you are likely to need substantial investments before you will become liable to the tax. For example, if your investments generate an average dividend of 4%, you would need to have £50,000 invested before the tax could be due.
2. Dividends could still be more tax-efficient than taking a salary
Even with the increase after April 2022, the rate charged for Dividend Tax means it could still make sense to take dividends out of your company as an income.
If you are a basic-rate taxpayer in 2021/22, you’ll pay 20% on any income above your Personal Allowance of £12,570. This compares with 7.5% Dividend Tax in the same tax year, or 8.75% after April 2022. This is still a saving of 12.5% and 11.25% respectively.
As a higher-rate taxpayer, you typically pay 40% Income Tax (2021/22). Assuming this remains the same, you’ll pay 6.25% less even after the increase comes into force in April 2022.
Additional-rate taxpayers will still save 5.65%, as the increased dividend rate will be 39.35% compared to the Income Tax rate of 45% – again assuming Income Tax remains the same as 2021/22.
Given current government borrowing in the wake of Covid, it’s probably safe to say Income Tax is unlikely to go down.
3. Reviewing your investments might make your dividends more tax-efficient
If you have shares in a company, you’ll know there are two ways to earn from them. The first is to sell the shares if they increase in value, and the second is to take dividends paid by the company to shareholders.
While dividends are never guaranteed and are paid completely at the company’s discretion, they can still be a good way to generate an income using investments. That said, in 2020 many companies cut dividends as they looked to conserve cash during Covid.
After receiving a reduced dividend income during the pandemic, you might feel the government’s increased tax rate is another blow to your earnings. The good news is that there might be a way to shield your dividend income from tax.
Put your investments into an ISA. Because dividends are classed as an income they are not taxed when they’re within an ISA. Besides this, any income your investments generate does not come off your Dividend Allowance.
With this in mind, it could be worth ensuring that as much of your investments as possible are in Stocks and Shares ISAs. One way to do this is to ensure you use all of your 2021/22 ISA allowance, which is £20,000.
Remember, the allowance runs out at the end of the tax year, meaning you cannot carry forward any unused amount. If you don’t use it, you lose it.
If you have old cash ISAs, you might want to consider switching these to a Stocks and Shares ISA as well. This could help generate additional tax-free dividends in the future, and potentially inflation-proof the cash.
If you would like to learn more about how investing could help inflation-proof your money, visit our recent blog.
Get in touch
If you are considering switching old Cash ISAs into Stocks and Shares ISAs, ensure you speak with your financial planner. They will confirm whether it’s right for you, the risk you could expose your money to and the growth potential you might enjoy.
Likewise, if you would like to discuss the impact of the new Dividend Tax on your investments, or would like to discuss your wealth more generally, contact your financial planner directly. Alternatively, contact us below.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.