The dividend allowance, introduced in 2016, reduced to £2,000 on 6 April 2018. The government estimate that 2.27 million individuals in 2018 will be impacted by this reduction. Some of those impacted will be investors and there is an opportunity for some simple planning in this area to avoid some unnecessary tax.
Reduction in allowance will cost investors’ money
The dividend allowance works as a zero rate band that overlaps the basic, higher and additional rate bands. An individual can from 6 April 2018 earn £2,000 of dividend income (the dividend allowance in 2017-2018 tax year was £5000) and pay 0% tax on it. This reduction to £2,000 will cost savers some money as shown below:
- £3,000 allowance reduction for
- a basic rate tax payer = £3,000 * 7.5% = £225
- a higher rate tax payer = £3,000 * 32.5% = £975
- an additional rate tax payer = £3,000 * 38.1% = £1,143
It isn’t just large Investments that are impacted
Depending on the yield being achieved by the equity investment(s) this reduction in the dividend allowance might impact more investors than you might imagine. If we take a 3% yield, investments above £67,000 would be impacted. If a 4% yield is achieved investment above £50,000 would produce dividends above the revised allowance. It is important to remember that investments within ISAs and Pensions generating dividends do not count towards the dividend allowance and are not liable to personal taxation.
Some simple planning can reduce or avoid the impact of this reduction
There is an opportunity to remind your clients’ of some simple steps to help maximise their investment returns. The reduction in dividend allowance acts as a further reason to consider the following:
1. Maximise tax efficient savings allowances
The ISA allowance for 2019/20 remains £20,000. Ensuring this is utilised in full is an obvious step. Reducing investments held outside of tax wrappers by placing the money into an ISA known as ‘bed & ISA’ can shelter the dividend yield from the tax highlighted above. It can also help to utilise the annual CGT exemption.
The annual allowance for pensions, £40,000 for 2019/20, also provides a similar opportunity to shelter investments from tax and reduces dividends received outside of tax wrappers. Investors do need to be comfortable that they can’t access the money freely once invested though.
2. Adjust the type of investments
If the allowances discussed above have been utilised, the way in which investment returns are achieved could be reviewed with some returns being achieved through interest and capital growth. This will depend on each client’s attitude to risk but could help reduce the dividend income received going forward.
3. Use spouses allowances
Where a client is married or in a civil partnership planning as a couple becomes very important to make the most of the tax allowances available. Each individual has the following for 2019/20:
- a personal allowance (£12,500)
- starting rate for savings (where earned income is below £17,500)
- a personal savings allowance (£1,000/£500/£0 dependent on earnings)
- a dividend allowance (£2,000)
If investments are all held in one of the couples name there is an opportunity to transfer some investments to the other individual to ensure these allowances are used to the couple’s advantage. If the transfer of investments is done in specie between spouses living together is transferred on a no loss no gain basis and does not create an immediate CGT liability.
4. Consider an investment bond
A life assurance (or redemption) bond can shelter investors from dividend taxation as the ownership of the investments yielding the dividends is the life company. Because of this ownership structure, dividends earned within the bond wrapper do not count towards the dividend allowance and are not liable to personal taxation whilst invested.
Investment bonds are taxed under chargeable event rules so further consideration is required to the net position on surrender to ensure the client is not liable to higher rates of tax on the bond gain than on receiving the dividends in a general investment account.
Reduction in dividend allowance doesn’t have to be bad news
Although reducing a tax allowance is never good news for an investor, it does provide the opportunity to speak to clients about the other allowances that are still available to them.
Last updated: April 2019