Diving into dividend tax

The dividend tax is changing in the new tax year (from 6 April 2023), so it’s a good time to deep dive into what dividends actually are, how dividend tax works and how it’s changing, and some best hacks on how to earn dividends without worrying about paying tax on them. 🤿

What are dividends? 🤔

When you buy an investment, it’s likely you’re doing it for the long-term goal: to make a profit when you come to sell it. But there’s another way you can earn money from many investments – dividends!

Dividends are a portion of the profits that companies and some funds pay out to their investors. You can think of them as the money you make from your investments while you hold them.

The size of the dividend you get is usually proportional to your stake in the company or fund. So the larger your investment in a company or fund, the larger your dividend tends to be.

Not all investments pay you dividends. Many large companies do – and most companies you can invest in on Dodl pay a regular dividend. But when a company has a poor run of performance it may halt its dividend payments. And some companies don’t pay any dividends at all – especially if its aim is to grow quickly by reinvesting their profits. 📈

Funds are a little different. Some pay out its dividends or income to its investors, and those funds are aptly named ‘income funds’. Others reinvest the dividends into the fund to boost its growth – those ones are called ‘accumulation funds’.

What is dividend tax? 💼

Dividend tax is the type of tax you pay on the dividend income you make from any investments (except those held in an ISA or pension).

If you have, or plan to buy, any investments which pay dividends, just keep one eye on dividend tax. Make sure you understand if and how it applies to you, and how it’s changing over the next few years.

Though this post hopes to lift the veil a bit on dividend tax – it’s not advice (remember, Dodl doesn’t do advice!). More info is available on the government’s dividend tax page and do seek personal tax advice if you need to.

What is the dividend allowance? 💸

The good news is that everyone can earn some money in dividends before they have to start paying tax. This tax-free amount is called the dividend allowance, and it currently sits at £2,000 for the 2022/23 tax year – but it’s getting smaller and smaller over the next few years.

Any amount you make above the allowance each year is taxable, and you’ll also have to let HMRC know about it. You can usually do this online or by contacting their helpline. 📞

What are the dividend tax rates? 📊

If you’ve used up your dividend allowance, the rate of tax you pay on your dividends depends on your other income e.g. your salary. After adding them to your other income, basic-rate taxpayers will pay 8.75%. Higher rate taxpayers pay 33.75% and for additional rate taxpayers it’s 39.35%.

 

Income rate	Dividend tax rate
Basic	8.75%
Higher	33.75%
Additional	39.35%

 

Here’s a quick example. If your investments have been paying out lots of lovely profits this year, 🤑 and you’ve made £2,500 in dividends, £500 of that will be taxable. Say you’re a basic rate taxpayer and adding this amount doesn’t sneak you up an income bracket, you’ll pay 8.75% of £500 in dividend tax. That works out as £43.75 off the top.

How is dividend tax changing? 📅

The tax rates aren’t changing but the allowance is. From 6 April 2023 the dividend allowance will be cut clean in half to £1,000, and from 6 April 2024 it’ll be halved again to just £500.  That means lots more people will have to start paying tax on their dividends over the next few years, and those who already pay it will pay bigger bills.

To put these changes into a little context, someone on a basic rate of income who makes £2,000 in dividends each year (outside an ISA or pension) would pay no tax on any of it currently. But from 6 April, £1,000 of their dividends would be taxable, meaning £87.50 back to HMRC, and from 6 April 2024 £1,500 of their dividends are taxable, so the tax shoots up again to £131.25.

Best investing hacks to save your dividends from tax 😎

Prioritise using your yearly tax-free account allowances. The ISA allowance is a sizeable £20,000 – you can put up to that amount into your investment ISA (and lifetime ISA – if you have one) each year and invest it all tax-free. Dividend tax can’t touch your investments when they’re safely wrapped up in an ISA.

And don’t forget the tax perks of your pension too. You can usually save up to £40,000 (£60,000 from 6 April 2023) or your salary (whichever is lower) to your pension each year. Again, whatever you invest your pension savings in can be left to grow and accumulate dividends tax-free.

ISAs, lifetime ISAs and pensions are most definitely your friends when it comes to investing in a tax-savvy way. So, if you’re thinking about starting to invest, it might be worth looking at these accounts first.

Check out the Dodl investment ISA, lifetime ISA and pension for more info on each. Or, if you’re already set up with them, give some thought to topping them up - to boost your tax-free investments for this year. 💪

 

Open a Dodl account today

 

🔔 Just remember with all these tax-related bits, tax rules can change (and clearly do!). The info in this article isn’t a substitute for personal tax advice so if you do need that, you’re best off contacting a professional tax adviser. And when you invest, the value of your investments can go down as well as up.