A consequence of George Osborne’s Budget on Wednesday may mean that individuals wish to reassess how their savings are invested. The Chancellor introduced changes to the taxation of dividend income starting with a dividend allowance of £5,000 a year for all taxpayers, from April 2016.
The next change is dependent on the amount of dividend income received. Once the new allowance has been exhausted, you will be assessed for additional tax subject to your taxable income. So if the dividends you receive push you into a higher rate income tax band you will pay further tax as shown in the table below:
|Dividend Tax Rates
|Basic rate taxpayer
|Higher rate taxpayer
|Additional rate taxpayer
Note: Whilst the tax credit inherent in a dividend is scrapped, this is not to say less tax has been paid. As an example currently a £1,000 dividend payment received has a tax credit of £111 (already deemed as paid), this is a fiction as in most cases tax is paid at source of 20% (corporation tax)
When looking at your investment portfolio, you need to lift up the bonnet to see if the portfolio has a focus towards generating an income. In an equity heavy portfolio this will largely be delivered through dividends.
As an example
An investor with a portfolio of £150,000 generating a dividend income or yield of 4%, £6,000 per year, has immediately filled their “tax free” dividend allowance (£5,000 -despite the Chancellor’s rhetoric they are not tax-free as most will have 20% corporation tax deducted at source). Depending upon their other taxable income there may be a liability for additional tax on the dividend.
An alternative approach could be to consider a total return investment style. A total-return portfolio maintains a blend of asset types with both growth potential as well as the ability to turn gains into income. So, with this investment option you use dividends, interest payments, capital appreciation and your original investment to generate income, if needed.
So how can the new taxation of dividend income be managed?
- Make use of your ISA allowances – unlimited dividends can be withdrawn from an ISA tax paid. The current allowance is £15,240 (£30,480 for a married couple). Make use of ISAs for dividend focused portfolios.
- Married couples should make sure that they use each relevant income tax allowances and tax bands
- Consider the use of pension contributions to reduce your taxable income
- As explained above, consider a ‘total return’ strategy where a combination of dividend income, interest and capital growth is sought. This is how Wingate manage most of their portfolios.
- Consider the use of International Portfolio Bonds, where taxation is deferred, with benefits being taken at a later date when other taxable income may have fallen
As is often the case, a change in fiscal policy will have repercussions on individual’s personal financial planning which reinforces the benefits of on-going reviews.