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Dividend taxation for investors

Since April 2016 dividends received by an investor have been considered gross following the abolition of the 10% tax credit. A dividend allowance has been in place within which all dividends received will be free from any tax liability. Initially the allowance was £5,000 but from 6 April 2018 it was reduced to £2,000. Dividend income in excess of this amount is liable to tax at the tax payer’s marginal rate which for dividends is:

  • 7.5% for basic rate tax payers,
  • 32.5% for higher rate tax payers and
  • 38.1% for additional rate tax payers.

Dividends within the £2,000 allowance still count towards the basic or higher rate bands and may therefore affect the rate of tax payable on dividends in excess of the band.

Dividends received within an ISA or a Pension do not fall within the dividend allowance.

Some case studies are provided below to show how the allowance interacts with other allowances and bands in different scenarios.

Case study 3 has been provided to show how, during the advice process, the choice of wrapper can provide different outcomes for your clients’ from an income tax perspective.

Case Study – Tom

Tom is 20 and still at university. He has a part time job earning £8,000 a year and an investment that his father gave him which generates a dividend income of £6,000.

Tom is a non-tax payer as his income is taxed as follows:

 

 

Amount of income within each band

 

Total

Personal Allowance

Basic rate band

Higher rate band

Employment Income

£8,000

£8,000

 

 

Dividend

£5,500

£3,850

£1,650

 

 

 

 

 

 

 

 

Tax liability within each band

Employment Income taxed at 20%

£0

 

£0

-

Dividend Allowance of £2,000 taxed at 0%

£1,650

 

£0

-

TOTAL TAX

 

 

£0

-

 

Case Study – Rachael

Rachael is 40 and is a higher rate tax payer. She earns £40,000 a year and has investments which provide the following income:

  • Interest £2,000
  • Dividends £10,000

Her income is taxed as follows:

 

 

Amount of income within each band

 

Total

Personal Allowance

Basic rate band

Higher rate band

Employment Income

£40,000

£11,850

£28,150

 

Interest

£2,000

 

£2,000

 

Dividend

£10,000

-

£4,350

£5,650

 

 

 

 

 

 

 

Tax liability within each band

Employment Income taxed at 20%

£40,000

 

£5,630

-

Interest within Personal Savings Allowance*

£500

 

£0

 

Interest taxed at 20%

£1,500

 

£300

 

Dividend Allowance taxed at 0%

£2,000

 

£0

-

Dividend taxed at 7.5%

£2,350

  £176.25  

Dividend taxed at 32.5%

£5,650

 

£1,836.25

TOTAL TAX

 

 

£6,106.25

£1,836.25

 

* As a higher rate tax payer, Rachael is only entitled to £500 personal savings allowance not the full £1,000 available to a basic rate tax payer

Case Study - Fred

Fred is 65 and is a basic rate tax payer.  His only income is his pension income of £38,000 gross each year.  He has £200,000 to invest, and would like an annual income of £10,000 from his investment to supplement this.

To provide this income the Adviser is considering investing in equities via an Old Mutual Wealth Collective Investment Account or an Offshore Bond with Old Mutual International.

Equities with a dividend yield of 5% would achieve the natural income he requires. The table below identifies the tax position on receipt of the income:

 

 

Amount of income within each band

 

Total

Personal Allowance

Basic rate band

Higher rate band

Pension Income

£38,000

£11,850

£26,150

 

Dividend

£10,000

-

£8,350

£1,650

 

 

 

 

 

 

 

Tax liability within each band

Pension Income @20%

£26,150

 

£5,230

-

Dividend Allowance @ 0%

£2,000

 

£0

-

Dividend taxed at 7.5%

£6,350

 

£476.25

-

Dividend taxed at 32.5%

£1,650

 

-

£536.25

TOTAL TAX

 

 

£5,706.25

£536.25

 

 

If Fred invested into an offshore bond instead, his tax position would be different:

A withdrawal of £10,000 each year would be within the 5% tax deferred allowance. As such, no chargeable event and therefore no tax liability would arise as can be seen in the table below:

 

 

Amount of income within each band

 

Total

Personal Allowance

Basic rate band

Higher rate band

Pension Income

£38,000

£11,850

£26,150

 

Bond Withdrawal
(within 5% tax deferred allowance)

£10,000

n/a

n/a

n/a

 

 

 

 

 

 

 

Tax liability within each band

Pension Income @20%

£26,150

 

£5,230

-

Tax on bond withdrawal

£10,000

 

-

-

TOTAL TAX

 

 

£5,230

-

 

Comparison of Fred’s tax position on the £10,000 withdrawal taking into account his £38,000 pension income

 

Offshore Bond

CIA - equities

Investment

£200,000

£200,000

Rate of Return

5% growth

5% yield

Dividend Income

-

£10,000

5% tax deferred allowance

£10,000

-

Chargeable Event?

No

n/a

Dividend Allowance

n/a

(£2,000)

Tax liability on the £10,000 withdrawal

none

£1,012.50

 


Fred’s Adviser could consider splitting the investment between collectives and an offshore bond in order to maximize the dividend allowance. This would ensure the dividend income fell within the dividend allowance and avoids all the income coming from the bond that is only tax deferred being taxed at a later date i.e. on full surrender:

Tax position if Fred’s investment is split equally between a bond and collectives

 

Offshore Bond

CIA - equities

Investment

£160,000

£40,000

Rate of Return

5% growth

5% yield

Dividend Income

-

£2,000

5% tax deferred allowance

£8,000

-

Chargeable Event?

No

n/a

Dividend Allowance

n/a

(£2,000)

Tax liability on the £10,000 withdrawal

none

none

 

This table assumes Fred’s income is as identified in the case study.


The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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