Interactive Investor

Dividend tax: how to avoid it

23rd September 2022 11:54

Kyle Caldwell from interactive investor

The dividend tax will be reversed next April. We run through the the best lines of defence for investors.

The 1.25 percentage point increase in the dividend tax will be reversed next April, it was announced in today’s mini-budget.

From the start of this tax year on 6 April, basic-rate taxpayers pay 8.75%, higher-rate taxpayers 33.75%, and additional-rate taxpayers pay 39.35% on dividends above £2,000.

However, from April 2023, basic-rate taxpayers will pay 7.5%, and higher-rate taxpayers 32.5%. Current additional-rate taxpayers will also pay 32.5%, following today’s separate announcement scrapping the additional rate of income tax.

The government said the change will benefit 2.6 million taxpayers, with an average benefit of £345.

Based on a yield of 3%, it requires a portfolio of £66,667 to generate £2,000 of dividend income. With a 4% yield, this figure drops to £50,000, and with a 5% yield it falls to £40,000.

How to minimise your dividend tax liability

The good news is that the dividend tax can be avoided by using an ISA. At present the annual allowance is £20,000 and £9,000 for a Junior ISA.

In addition, the personal allowance of £12,570 may also cover dividend income if your other income sources are worth less than that sum.

Investors with substantial holdings outside ISAs should consider moving them into the wrapper. The transfer, however, will involve selling and buying back shares, which could trigger a capital gains tax (CGT) bill. The CGT annual allowance is £12,300. The process known as 'bed and ISA'  is a straightforward way to fund your ISA using your existing investments. 

Self-invested personal pensions are also beneficial, in that dividends are tax-free within the wrapper. But bear in mind withdrawals that exceed the 25% tax-free allowance will be taxed as income.

To sum up, tax shelters are investors’ best line of defence.

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