After a bruising 2020, dividend investors now face another curveball — this time from the Chancellor.
Rishi Sunak stated in his Budget that the Treasury will increase taxes on dividends in April. Investors will then pay an additional 1.25 %.
The rise, which could see investors pay £3 billion more over five years, was part of Boris Johnson’s September plan to raise more money for the NHS.
Tax hikes: If an investor earns £10,000 from dividends next year, after factoring in their £2,000 allowance, their tax bill will rise by £100: 1.25% of £8,000
Experts believe that the move will benefit older investors, even though it may not seem like much.
That’s because many pursue dividends (a style known as income investing) as a way of providing regular cash in retirement.
What’s more, the move will disproportionately affect investors paying the basic rate of income tax — i.e. The less well-off.
Taxes are like any other subject. Understanding the current system is key.
On top of their personal income allowance, all investors receive a £2,000 dividend allowance, with payments above that subject to tax.
Basic-rate taxpayers currently receive 7.5% on dividend income. Higher and additional rate earners, however, pay 32.5% and 38.1% respectively. These rates will rise to 8.75%, 33.75%, and 39.35% respectively as of April.
So if an investor earns £10,000 from dividends next year, after factoring in their £2,000 allowance their tax bill will rise by £100: 1.25 per cent of £8,000.
But for a basic-rate payer, who currently only pays £600 in tax on this income, it is a far more noticeable jump than for a higher-rate payer (whose tax will go up to £2,700 from £2,600).
The news comes as the FTSE 100 is set to pay out £84.1 billion in dividends this year, with initial signs pointing to a strong year in 2022. ‘UK dividends have generally recovered well from the pandemic,’ says Hargreaves Lansdown’s Nicholas Hyett.
‘The FTSE 100 currently offers a yield — the percentage of your investment paid back in dividends — of nearly 3.5 per cent.’
Evraz, a steelmaker, and Rio Tinto, a miner, are expected to lead the pack with projected yields of 17.9 percent and 17.8 percent respectively.
Of course, similar payouts aren’t guaranteed in 2022 and investors need to think carefully about how inflation might affect company profits.
Divi grab: Rishi Sunak (pictured, in his budget) confirmed that the Treasury would increase taxes on dividends in April. Investors will be paying an additional 1.25% starting April
It’s why investors look carefully at the dividend cover: which shows how many times the company could pay out based on current profits.
‘Historically, income investors have also turned to defensive sectors, like consumer goods and pharmaceuticals when inflation rises,’ says Mr Hyett.
‘These companies enjoy strong brand power or are essential purposes, so they can pass on higher costs to customers.’
How can investors reduce their tax bill?
To begin, funds and shares in stocks and shares ISAs are exempted from capital gains tax as well as dividend tax.
It’s why any financial advisor worth their salt will tell you to always use your annual £20,000 ISA allowance — as once it’s gone, you can’t get it back.
For longer-term investors, though, it hasn’t always been so easy. Personal ISA allowances haven’t always been as generous as they are now. In fact, less than 15 years ago, they were only £7,200.
This means that many older investors will have accumulated nest eggs beyond their tax-free wrapper. These nest eggs have likely grown over the years.
‘Even if you’ve got a sizeable pot outside of your ISA, there are ways you can reduce your tax bill,’ says Laura Suter, a personal finance expert with investment platform AJ Bell.
The overall strategy, she says, is to sell some of your shares and then re-purchase them in an ISA (a move referred to as ‘bed and ISA’).
‘If you do this now, and then again in April when the new allowance begins, you could protect £40,000 before the new rate takes hold,’ she says. ‘If you’re a couple, you can effectively double your allowance: sheltering £80,000 from the taxman.’
It may take some planning to get it right, especially for those with larger portfolios.
Capital gains tax is something you should consider if your shares have increased in value over time.
Investors currently receive an annual allowance of £12,300: with any gains above that subject to tax at either 10 per cent or 20 per cent.
However, this applies only to your actual gains and not your total assets value.
Buying and selling shares will also result in paying transaction fees (potentially around £9.95 per trade) to your investment platform.
Ms. Suter advises that investors choose the largest dividend-paying shares and funds to invest in, rather than randomly moving between them.
‘You should rank their assets from the highest-paying to the lowest — focusing on pounds and pence, rather than the percentage yield,’ she says.
All future gains and dividends after investments have been re-bedded into an ISA are exempt from tax.
Meanwhile investors with spare cash — and ISA allowance — can take some of the risk out of dividend-hunting by looking at income-focused funds. Experts at AJ Bell chose the Man GLG income fund, which paid 4.76 per cent over the past year.
The fund spreads investors’ capital across historically reliable dividend stocks — including Shell, Rio Tinto, Imperial Brands and Barclays.
By reinvesting their dividends, investors could have turned £10,000 into £14,400 in five years.
You may find it cheaper to increase your income by using platforms that offer lower or even no dealing charges for funds.
moneymail@dailymail.co.uk