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How the Dividend Allowance cut affects you

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

The £5,000 tax-free Dividend Allowance was cut to £2,000 in April 2018. The reduction means that tax-efficient wrappers such as ISAs will become more important for investors with dividends in excess of the allowance who are seeking to mitigate their increased tax exposure.

Click to toggle accordion What you’ll learn:

How the Dividend Allowance is changing.

Who the change will affect.

Why the reduction in the Allowance makes ISAs more important for investors who receive substantial dividends.

The amount of dividends investors can receive tax-free fell from £5,000 to £2,000 on 6 April 2018, following the Chancellor of the Exchequer Philip Hammond’s decision to cut the Dividend Allowance in the 2017 Budget.1

The change was announced just a year after the Dividend Allowance came into effect in April 2016.

Any dividend income above the new £2,000 allowance attracts tax at 7.5% for basic rate taxpayers. Higher-rate taxpayers’ dividends are taxed at 32.5%, and additional rate taxpayers pay 38.1% tax.2

As this change shows, tax rules can and do change over time, and their effect on you depends on your individual circumstances, which can also change. Remember too that investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, please seek independent financial advice.

Who will the Dividend Allowance cut affect?

Director shareholders of private companies paying themselves in the form of dividends, rather than salary, will be affected by the reduction in the Allowance. The change will also impact investors with portfolios generating more than £2,000 of income a year which are held outside ISAs or pensions.3

Investors don’t need a very large portfolio to receive dividend income over £2,000, with sums around £50,000 in shares typically producing around this sum.4

According to accountants Blick Rothenberg, a higher-rate taxpayer with an investment portfolio generating £5,000 of dividends a year will pay £975 tax on this following the change, while an additional rate taxpayer will pay £1,143. The cost to a basic-rate taxpayer will be £225.5

The Government estimates that the dividend tax cut will affect around 2.27m individuals in 2018-19 with an average loss of around £315.6

The benefits of ISAs

Those receiving dividends on investments should remember that changes to the Dividend Allowance will only affect investments held outside an ISA or a pension. Dividend income received within ISAs or pensions is tax-free.

The cut makes holding investments within an ISA wrapper more important for those receiving dividends in excess of the allowance. You can shelter up to £20,000 in a tax-efficient investment ISA, cash ISA, innovative finance ISA, a lifetime ISA or any combination of these before the tax year ends on 5 April 2019. However, with a lifetime ISA, you can only pay in up to £4,000 of your £20,000 allowance.

Dividend options

Dividends may either be taken as a cash payout or they can be reinvested into your investment account to boost the potential for growth over time.

If you choose to reinvest dividends, these can either take the form of SCRIP dividends where they are offered by the company, and instead of cash being received, the dividend is paid in new shares and stamp duty is not paid. Alternatively the cash dividend received can be used to purchase additional shares in the company paying the dividend, known as dividend reinvestment. This increases the number of shares held by investors over time and will impact returns, growing the sum invested at a faster rate than if dividends were not reinvested.

You can also opt to receive cash and either choose how to reinvest that yourself or to pay out the dividend to a bank account to provide an income stream. If you have a Smart Investor account log in and select investment settings to instruct us how you want to receive your investment income. You can have different settings on each of your accounts.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change in future. Their effects on you will depend on your individual circumstances.

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