Twenty-nine years ago when I began this role, I was always told governments never made tax legislation retrospective – i.e. going back on their word, which affected people who had made plans based on previous legislation – Really?
In a world of virtually no interest on savings, investors have turned to their dividends to produce a return for their income, but the ‘about turn’ on tax, and the use of a tax-free dividend allowance has left the investor’s head spinning again.
Dividends have soared for UK companies since the drop in sterling with a record first quarter and are expected to increase to £84.6bn. (1)
So with the slashing of the tax free allowance from £5,000 to £2,000 due to be put in place from April 2018, the government would have been clobbering those with portfolios in dividend-paying shares and investment funds held outside of ISAs and pensions. They estimated they would hit 2.27 million people grabbing £2.6bn from the taxpayer. (2)
The above threshold is the amount after which you have to pay tax on your dividend income for your shares.
However, a short term ‘about, about-turn’ for no apparent reason other than a snap election they called, has meant that certain tax increases have been put on the sideboard. Most financial commentators I know believe that after an election victory these taxes along with the digital taxes will be put in place.
I suppose it depends on who you trust, but investors would be very wise to assume this is a very temporary measure.
Larger investors beware: An investor with £125,000 in shares for example, with a yield (income) on their shares of 4% would pay £975 more if they were a higher rate tax payer. (2)
Anyone with a portfolio of over £50,000 would generally be affected if they want to maintain a tax-free income. In fact if we were to use the FTSE100 as an example, the current yield on that is 3.66%. (3) That would mean investors with £54,644 or more will have a new tax bill post April 2018.
So what are the options to keep this income in your pocket rather than watch it float away?
Firstly, you will need to pay attention with your investment/financial adviser to the funds you hold and also which tax wrapper they are invested under.
ISAs and Pensions are very tax efficient whilst others such as collectives (unit trusts/OEICs/investments trusts) and investment bonds can have varying tax breaks depending on your tax position so this will be a key time to rebalance.
Many investors are unaware that if they have money in an investment fund, which has less than 61% of its investments held in fixed interest stock, the subsequent income will be taxed as a dividend.
Some very easy moves to protect the tax payable is to transfer the shares you have into an ISA. The allowance for an ISA has just increased to £20,000 per person and this would be crazy to miss out on.
You simply sell the shares, open the ISA and buy the shares back. Now it’s tax-free. Remember there may be a movement up or down in the share price of the share you are buying in between the sale and subsequent repurchase.
Another option is to transfer the shares into your self invested personal pension (SIPP). We’ve covered the Inheritance Tax and tax benefits of the SIPP before but as above the dividends and growth are free of tax.
You may also consider the transfer of shares between married couples/civil partnerships. For example if your partner wasn’t a taxpayer you could transfer an amount to use their dividend income allowance.
Owners of private unlisted companies could also consider this, as these are ineligible for an ISA.
Finally, it’s worth remembering that higher dividend paying investments should first be moved into ISAs/SIPPs before investments that achieve more of their returns by growth.
Certain funds you will be invested into achieve their performance through income producing assets, whereas others achieve it by investing into shares that achieve their return by the growth in the share price of the companies they invest into.
These growth funds may be better invested within the aforementioned collectives as they are allowed an annual capital gains exemption per year on growth of £11,300 (for the 2017/2018 year). Investors could then avail of that allowance on a year-by-year allowance creating a very tax efficient income.
Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.Last modified: June 10, 2021