Be wary of the £90,000 dividend tax trap
In April last year, the dividend allowance fell from £5,000 to £2,000. Assuming a dividend yield of 4.3% (the current yield on the FTSE All Share ex Investment Companies), this shrinks the amount you can hold outside an ISA or pension without facing dividend tax by £90,000.
The best way to avoid paying tax on dividends is to hold shares in an Isa. For dividends on shares held outside an Isa, basic rate taxpayers are taxed at 7.5% on the excess, higher rate taxpayers at 32.5% and additional rate taxpayers at 38.1%.
Rising dividends yields or further cuts in the allowance could see investors facing dividend tax in future. Where possible, says Hargreaves, it is worth trying to channel as much of your savings as possible into a tax sheltered product. Investors can use the Bed & ISA process – whereby they sell shares they own and buy them back within an Isa wrapper – to protect £20,000 of existing investments from tax this year.
When doing this, you should prioritise those shares with the highest dividends. This will leave more growth-oriented investments outside the tax wrappers.
Sarah Coles, personal finance analyst, Hargreaves Lansdown, said: “The stock market has seen an income bonanza. In 2018, the total paid out in dividends hit a record high. In more recent months, dividends have remained fairly resilient, and as share prices backed off from the highs of last spring, the dividend yield has risen to around 4.3%.
“Record dividends are great news for investors, who can boost their investments significantly by reinvesting them, or withdraw more income without eroding their money. Sadly there’s a tax-shaped fly in the ointment, because higher dividends can mean shock tax bills.”