Last Tuesday saw a range of new tax measures, as well as other changes to benefits, announced by the government in a bid to raise more revenue and fund two key priorities – the National Health Service and a reform of social care.
The plans included an increase to National Insurance of 1.25 percentage points in the next tax year, to be transformed into a 1.25 per ent levy on ‘earned income’ the following year; a one-year break of the triple-lock mechanism for uprating the state pension, doing away with the earnings measure to prevent an unaffordable rise; and an increase to dividend taxes. These tax rises will apply in the 2022-23 tax year, which starts on 6 April 2022 and ends on 5 April 2023.
Dividends are a distribution of the profits a company makes, paid to shareholders, usually twice a year. And yes, there is a tax to pay, which is lower than income tax rates to incentivise people to hold shares and invest. However, the rates are linked, as the rate of dividend tax you pay is split into bands with the same thresholds as income tax. So if you’re a basic-rate taxpayer (20 per cent in England, Wales and Northern Ireland, or 21 per cent in Scotland), you’ll pay the basic rate of dividend tax, which is currently 7 per cent. Higher-rate taxpayers pay 32.5 per cent and additional-rate taxpayers pay 38.1 per cent.
This tax is only payable once you earn more than £2,000 in dividends. If dividends are your only, or main source of income, you’ll also have some or all your personal tax-free allowance that can be used before tax is payable. So on top of the £2,000 dividend allowance, you could earn another £12,570 tax-free in 2021-22.
Indeed, the government has stated that with the personal allowance and the tax-free dividend allowance, around six in 10 people who hold shares outside of an Isa will not be affected by the changes.
Do you believe you’ll fall into this camp? In order to breach the tax-free dividend allowance, you’ll need a hefty amount in dividend-paying stocks. Analysis from investment platform AJ Bell suggests that this year, the average dividend yield of the companies in the FTSE 100 stock exchange is forecast to be 3.7 per cent. In order to generate £2,000 in dividends income in a year, you’d need around £54,000 invested.
If you still think you’ll be affected, you’ll pay an extra 1.25 per cent on top of the existing rates. So a basic-rate taxpayer will pay 8.25 per cent; a higher-rate taxpayer will pay 33.75% and an additional-rate taxpayer will pay 39.35 per cent.
So what can you do? Well you’re already investing smartly by making use of your stocks and shares Isas, which protect your savings from dividend tax. You could look to transfer your investments into an Isa over the next couple of years to protect the remainder of your portfolio – remember you can invest £20,000 a year into an Isa. You may want to prioritise this over cash savings, if you hold both, as cash savings held outside of an Isa also benefit from the tax-free personal savings allowances (£1,000 a year for basic-rate taxpayers and £500 for higher-rate taxpayers).
As these new rates apply to dividends earned in the next tax year, you have plenty of time to prepare. If you submit a tax return, the tax will not need to be paid until 31 January 2024 at the latest. This is only relevant to those who earn more than £10,000 in dividends. If you earn less, tell HMRC and it can adjust your tax code so that any tax due is deducted from your salary or pension.
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