United Kingdom

87% dividend tax grab from poorest hits hopes of improved income

Cash grab: The hike in dividend taxes will eat into the income of many households who rely upon divis to supplement their finances

Shareholder dividends from UK listed companies are in bounce-back mode after the ending of lockdown restrictions and a recovery in the economy. But the prospect of an improved income from shares in the coming months and years has been dampened somewhat by the Government's latest tax assault on dividend income. 

Announced this month as part of measures to boost the National Health Service, the hike in dividend taxes will eat into the income of many households who rely upon regular divis to supplement their finances. It comes into force at the start of the new tax year in April. 

Moira O'Neill, head of personal finance at wealth manager Interactive Investor, describes the Government grab as 'a tax on the time poor and on the bereaved widow left with a pile of share certificates to sort through'. She says it will be the over55s – the biggest holders of dividend-friendly companies such as AstraZeneca, BP and GlaxoSmith -Kline – who will take the biggest hit. 

Analysis of the impact of these changes has been conducted for Wealth by wealth manager AJ Bell. Not only has it looked at the negative impact of the higher tax rates that kick in from April 6 next year, but it has also quantified the cumulative cost of tax changes to dividends – and a reduction in the annual tax-free dividend allowance – since the tax year starting April 2016.  

It does not make for pleasant reading. Once the latest changes kick in from April next year, the tax plundered from dividend income will have increased in some cases by more than 80 per cent, with basic rate taxpayers taking the biggest hit. 

For the tax year starting April 2016, investors enjoyed an annual dividend tax free allowance of £5,000. This meant that all dividend payments below this amount were protected from further tax – and even then sums above it could still be tax-free if an investor had any remaining personal allowance available (the amount of income a person is allowed to receive without paying tax on it). On dividends above £5,000 – and assuming no available personal allowance – the tax rate varied according to whether an investor was a basic, higher or additional rate taxpayer. The rates were 7.5 per cent, 32.5 per cent and 38.1 per cent respectively. 

In April 2019, the tax rates stayed the same, but the annual dividend allowance was squeezed to £2,000. From April next year, the allowance stays the same, but the tax rates jump to 8.75 per cent, 33.75 per cent and 39.35 per cent respectively.

AJ Bell has calculated (see table) that a basic rate taxpayer with £10,000 annual dividend income will have had to pay £375 of tax on this sum in the tax year starting April 2016, jumping to £600 in April 2019. In the next tax year, the tax bill will rise again to £700 – an increase since the 2016 tax year of 87 per cent. For higher and additional rate taxpayers, the respective increases are 66 and 65 per cent. 

Laura Suter, AJ Bell's head of personal finance, says many investors are now facing a 'double tax squeeze' on their dividend income. It's a tax hit that Tom O'Brien, financial planner at wealth manager Brewin Dolphin, says investors should not underestimate. 'Commonly, the change has been announced as a 1.25 per cent increase, but in reality it is a tax increase of 16.67 per cent.' 

Jason Hollands, of wealth manager Tilney Smith & Williamson, is 'disappointed' to see taxes on dividends rising. 'We need to encourage long-term investing in the UK if we want a dynamic economy to flourish,' he says. Yet, he says many investors can avoid these higher taxes by transfer ing shares or funds into wrappers such as Isas and pensions – where dividend taxes do not apply. This process is called 'bed and Isa' or 'bed and pension', but there are costs involved and capital gains tax may be payable. 

Married couples and civil partners can also switch shares and funds between each other so as to take advantage of two sets of dividend allowances. These are called 'interspousal transfers' – and can be easily arranged by a wealth manager or broker.

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