If you hold stockmarket assets in cash or in your SIPP, or if you’re a small business owner, find out whether you’re a winner or a loser with the forthcoming dividend tax changes
From 6 April 2016, The Tax Credit On Dividends Will Be Abolished
The New Tax-Free Dividend Allowance
When the new rules come into play next year, you will enjoy a tax-free dividend allowance of £5,000. Dividends in excess of this will be taxed at special rates according to whether the income falls into your basic, higher or additional rate bands.
The government is hoping to raise £6.8 billion over the next five years by replacing the 10 per cent tax credit with the new tax-free dividend allowance. Coupled with this measure, all tax bands will see a 7.5 per cent increase applied. Higher rate and additional rate taxpayers will have to pay 32.5 per cent and 38.1 per cent respectively from April 2016, up from 25 per cent and 30.6 per cent.
How A Dividend Is Taxed Now
At the moment, you pay tax on a dividend and its accompanying tax credit. The total dividend plus tax credit is calculated by dividing the dividend payment received by 0.9. Here’s an example.
A dividend payment of £1,800 is a dividend plus a tax credit of £200 (£1,800 divided by 0.9). The tax credit will be scrapped after 5 April 2016.
If you receive a dividend in the current tax year and you are a higher rate taxpayer, you pay a special rate of tax of 22.5 per cent on the dividend plus the tax credit. You are deemed to have paid an extra 10 per cent in the form of the tax credit. It follows that on a dividend of £1,800 plus a £200 tax credit, the higher rate tax charge in 2015/16 is £450.
How A Dividend Will Be Taxed From Next Year
From 2016/17, a dividend payment will be taxable on its own, without the extra tax credit. The new tax rates will reflect this. As at present, dividends will form the top segment of your income. The rate will depend on the extent to which this top slice of income comes into a particular tax band.
Tax On A Dividend If You're A Non-Taxpayer
If you’re a non-taxpayer, currently you pay no tax on a dividend and this will continue. In future, because the first £5,000 of your dividends will be tax-free, you could be a winner if your dividends fall within this limit.
Tax On A Dividend If You're A Basic Rate Taxpayer
If you’re a basic rate taxpayer, you currently pay no tax on a dividend. From April 2016, for dividends above the new allowance, you’ll pay a tax rate of 7.5 per cent on any dividend received. That’s £135 on a dividend of £1,800. As a result, if you have dividends of more than £5,000, you’ll be a bit worse off.
Tax On A Dividend If You're An Higher Rate Taxpayer
If you’re a higher rate taxpayer who normally pays 40 per cent tax on your savings income or earnings, you currently pay 22.5 per cent tax on the dividend plus tax credit. That’s £225 on the £1,000. This is equivalent to 25 per cent of the £1,800 dividend payment excluding the tax credit. From 6 April 2016, for dividends above the allowance, you’ll pay 25 per cent plus an additional 7.5 per cent dividend tax on a dividend payment. That’s a total rate of 32.5 per cent. On the £1,800 dividend you receive, the tax will be £585. From next year, you’ll be worse off to the extent your dividends exceed £21,667.
Tax On A Dividend If You're An Additional Rate Taxpayer
If you’re an additional rate taxpayer, you pay 45 per cent tax on your interest and earnings. The current rate of tax on a dividend plus tax credit is 27.5 per cent. That’s equivalent to 30.6 per cent on the dividend payment without the tax credit. Next year there will be an extra 7.5 per cent added to this, making the total new tax rate on dividends 38.1 per cent. On the £1,800 dividend, the tax payment will be £685.80. From next year, you’ll be worse off to the extent your dividends exceed £25,370.
A Summary Of Dividend Winners And Losers
There aren't any winners among basic rate taxpayers, who’ll either pay the same amount of tax (none) or more under the new rules. It’s pretty simple: if you receive more than £5,000 in dividends in a year outside pensions and ISAs, and you've already used up your personal allowance, you'll pay more tax.
With higher rate taxpayers, it gets more complicated. Within this group, some will pay less tax under the new system than the old.
Any higher rate taxpayer earning less than £5,000 a year from dividends is an obvious winner. You’ll pay no tax on that income under the new system, whereas you would have paid 25 per cent previously. If your dividends are exactly £5,000, you’ll save £1,250.
If you earn above this, you might also benefit. As it indicates above, you can receive £21,667 in dividend payments each year before paying more tax if you’re a higher rate tax payer. And £25,370 if you’re an additional rate taxpayer.
While there are some winners, the headline figure doesn't lie: the Treasury expects to raise £6.8 billion over the next five years through this measure. Taken as a whole, it represents a tax hike, and investors of varying degrees of wealth could all be affected.
Small Business Owners Could Affected By The Dividend Change Too
Many small business owners draw large dividends from their businesses in an attempt to reduce the amount of National Insurance Contributions paid by them and their company. They will be caught by these changes.
Here’s an enlightening article from New Model Adviser which shows how independent financial advisers are considering this change in dividend taxation, from both their own perspective and on behalf of their clients.
Three Tax Planning Dividend Strategies To Consider
- You should ensure your spouse or civil partner is in a position to make use of their £5,000 dividend allowance by balancing out enough of your investments to ensure this happens.
- Watch out for quoted companies to pay special dividends this year and bring forward any dividends that may otherwise have been payable early in 2016/17.
- Business owners should make sure shares are in the right hands and try to boost dividend payments this year before the tax goes up. Despite the increase in tax, it’s likely that it will remain more tax efficient to draw dividends rather than take salary/bonuses to save National Insurance Contributions.
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