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How to beat the dividend allowance cut

Paloma Kubiak
Written By:
Paloma Kubiak

The dividend allowance will be cut in April but there are ways to shield your portfolio from tax.

From 6 April, the tax-free dividend allowance will be cut from £5,000 to £2,000, a measure introduced in the 2017 Budget.

The move will impact employees and directors of small businesses who remunerate themselves partly or wholly through dividends rather than a salary.

It could also hurt investors with dividend generating shares and funds held outside of ISAs and pensions.

The government estimates around 2.27 million individuals will be affected with an average loss of £315.

Currently, any dividend income above the £5,000 allowance is taxed at the following rates:

  • Basic rate taxpayer – 7.5%
  • Higher rate taxpayer – 32.5%
  • Additional rate taxpayers and trustees – 38.1%.

According to calculations by Hargreaves Lansdown, only those with around £140,000 or more in investments are hit with the taxes (assuming 3.5% yield).

But once the dividend allowance falls to £2,000 in the new tax year, this could impact anyone with investments of around £55,000 or more outside a pension or ISA.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, said the cut will leave many investors with a “bitter taste in their mouth”.

She said: “To make matters worse, it may hit many of the investors who turned to income-generating investments because they were so disappointed with savings rates – who now face yet another attack on their income.”

“Fortunately, you can still take steps to shelter your dividends from tax. These are worth taking, even if you don’t currently earn £2,000 in dividends, because in future your investments may grow, the yield could rise, or the dividend allowance could face the chop again. The £5,000 limit was only around for two years, so there’s no saying how long the £2,000 limit will stick around.”

Five ways to avoid the dividend tax

Coles lists the following tips to help investors beat the dividend tax:

1) Take advantage of this year’s ISA allowance

Investments within ISAs aren’t subject to the dividend tax, so in the current 2017/18 tax year, you can move up to £20,000 of investments into ISA wrappers. You’ll need to use the Bed & ISA process. This involves selling stockmarket investments to crystalise gains – ensuring your gains fall within the annual capital gains tax allowance (£11,300 currently). The money can then be reinvested in the same assets within an ISA, to protect it from dividend and capital gains tax in future.

2) Take advantage of your ISA allowance on the first day of the new tax year

From 6 April 2018, you will have a new ISA allowance to take advantage of. At the very start of the new tax year – before you have earned any dividends – you can transfer another £20,000 into ISAs using the Bed & ISA process. In the new tax year, you will actually have a capital gains tax allowance of £11,700.

3) Use your spouse’s allowance

If you’re married and your spouse isn’t using their ISA allowances, you can give assets to them without generating any kind of tax charge. They can then put those assets into an ISA using the Bed & ISA process. This is known as Bed & Spouse & ISA.

If they aren’t using their own dividend allowance, you could also give them assets generating dividends of up to £2,000.

Using a combination of these three things, you can shelter £80,000 of investments in ISAs, and hold £110,000 outside an ISA while remaining within your tax-free dividend allowance.

4) Use your pension allowance

You can use a Bed & SIPP, which works similarly to a Bed & ISA, but you are sheltering investments in a pension instead of an ISA. It has the additional advantage of offering an immediate 20% tax relief boost. Higher rate taxpayers receive additional tax relief on Bed & SIPP as they do with normal pension contributions. You can also use Bed & Spouse & SIPP.

In the current tax year, both you and your spouse can make pension contributions up to either £40,000, or your earnings, whichever is lower. Non-tax-payers can contribute up to £3,600 a year.

There are, however, three things to bear in mind:

  • Bed & SIPP requires selling investments and crystalising gains, so if you have used all your capital gains tax allowance doing Bed & ISA you won’t have any left to do Bed & SIPP.
  • You need to be confident you’re comfortable tying up your money until at least the age of 55.
  • And when you come to take money from your pension, after the 25% tax free cash, you will pay income tax at your marginal rate on the balance.

5) Consider growth investments

If you can’t use ISAs or pensions to shelter all your portfolio from tax, you can consider how you hold the growth and income-generating parts of your portfolio.

You can focus on dividend-producing investments within the portion of your portfolio held in an ISA, and prioritise generating growth on investments outside the ISA.

You will then have the opportunity to manage how you take your gains in order to make the most of your capital gains tax allowances.