Dividend rate changes explained

Dividend tax is changing. Find out how your clients will be impacted, and what you can do to help

Dividends have long been an attractive means of generating income for investors, warranting lower tax than salaries and pensions.

Now, in a move to support the NHS, health and social care, the government is increasing tax on dividends from the start of the 2022/23 tax year.   

Those earning dividends are now set to pay 1.25% more tax, it’s vital to quell the concerns of your clients and help them prepare for the upcoming changes.   

What are dividends? 

Investors earn dividends when the company in which they have shares distributes – or ‘divides’ – its profits to shareholders.

Generally, this will be companies that have passed their fastest growth phase, meaning investors receive a secure and steady income and avoid the volatility of the wider stock market while improving their investment portfolio.  

Shareholders can be more confident that their investment will create a consistent return and, importantly, is less likely to fall in value than more unstable markets.

Plus, any underlying growth may also increase the value of the dividends that are paid out.  

In paying these regular and stable dividends, companies create a more attractive proposition to investors despite any stagnation in growth, thus retaining their investment.

How much they pay as a dividend is at their discretion, provided it has sufficient post-tax profits to make the payments. Indeed, the management teams making the decisions on paying dividends will likely have long-term track records of judicious allocation of company cashflow – but this is often the sign of a strong company with sustainable competitive advantages.

Ultimately, dividends can provide an objective measure of a company’s value and profitability. 

What are the tax changes? 

Shareholders earning dividends have a tax-free dividend allowance, in addition to a personal allowance of £12,500.

This tax-free dividend allowance remains at £2,000, after being cut from £5,000 in 2017/18. But above this, tax is paid based on a rate of income, and this is what is increasing at the start of the 2022/23 tax year.  

Here is a table that illustrates the incoming changes: 

The initial £2,000 tax-free dividend allowance means only a relatively large portfolio outside an ISA will warrant dividend tax. The below example from the government website offers a good insight into the implications of dividend tax. 

You get £3,000 in dividends and earn £29,570 in wages in the 2020 to 2021 tax year. 

This gives you a total income of £32,570. 

You have a Personal Allowance of £12,570. Take this off your total income to leave a taxable income of £20,000. 

This is in the basic rate tax band, so you would pay: 

• 20% tax on £17,000 of wages 

• no tax on £2,000 of dividends, because of the dividend allowance 

• 7.5% tax on £1,000 of dividends 

Why is it happening? 

In the aftermath of the Covid-19 pandemic, our health services require more funding to deal with a growing patient backlog. In addition, the ongoing issue of social care funding has been placed firmly beneath the spotlight throughout the pandemic.

Despite the raising of council tax by 3% more than the capped increase from some councils, more needs to be done financially to fully tackle the issues surrounding social care.  

As such, the government’s plan to raise dividend tax rates is expected to help fund its £12bn-a-year plan to resolve these issues, as part of a wider scheme.

The Prime Minister outlined broad changes last year that will see the Treasury raise UK-wide NICs by 1.25 percentage points a year, raising an initial £36bn for the NHS in the next three years. 

What does it mean for investors? 

Considering the combination of a tax-free dividend allowance and a personal allowance, the government estimates that around 60% of those with dividend income (outside of ISAs) aren’t expected to be pay dividend tax, and therefore will not be impacted by the upcoming changes in 2022-23. 

For investors that receive dividend payments beyond the tax-free allowances, the amount of tax payable will be worked out between salary, pension, property, savings and dividend income – along with any capital gains.  

Investors should be aware that dividend tax does not just apply to income from shares; it also need to be paid on the income received from funds that invest in shares on the investor’s behalf. For holdings in mutual funds, like an investment trust, dividend tax must be paid if they are investing in equities.

However, if an investor holds bond funds, this income counts as interest and would be taxed as savings income.   

How can you help your clients prepare? 

Rising taxes will always be a cause for concern for investors, so it’s important that you’re able to offer them expert advice on how best to navigate the rise in dividend tax rates.

To help them prepare, use the following questions as a base:   

• Are you earning dividends of more than £2,000 per year?  

• Are you aware of your income tax band, and what this will mean for the amount of dividends tax you pay? 

• Are you aware of the date when you will be paying a higher rate of dividend tax? 

• Are you keeping your shares (dividend-paying or otherwise) in a stocks & shares ISA as far as possible, to minimise tax?   

For additional preparation, it’s worth letting your client know that those using an ISA can avoid the tax rise because investment returns are not subject to income tax, capital gains tax or dividend tax. 

Currently, an individual can place £20,000 per year into an ISA and £9,000 into a Junior ISA on behalf of their children, while a family of four can place £58,000 each tax year into ISAs. 

Keeping your clients one step ahead will ensure there are no unknowns, meaning you can prepare for their financial future without any hiccups. Join the 27,000 independent financial advisers who use Unbiased to grow their business. Discover the plan that’s right for you.