Early tax planning can help reduce the effect of this year’s dividend allowance changes, writes Andy Woollon
From April this year, the tax free dividend allowance will be slashed from £5,000 to £2,000 – more than halving the amount investors can receive in dividends before paying any tax.
Among those hardest hit will be small business owners who pay themselves by dividends, but it will also affect investors, especially those in retirement, who are heavily dependent on income from shares or funds.
The tax grab will mean basic rate taxpayers (BRT) with dividends of £5,000 will pay an extra £225 in tax at 7.5%, higher rate taxpayers (HRT) £975 in tax at 32.5% and additional rate taxpayers (ART) £1,143 in tax at 38.1%, on the lost allowance.
The table shows the amount of dividends that a client would have to receive from all sources from 6 April 2018, at which point they will pay more tax (after taking into account the combined effect of the dividend allowance and dividend tax rate).
The ‘portfolio size’ indicates the equivalent value of a client’s unwrapped portfolio of collective investment funds (based on a fund distribution yield of 4%) that would generate these levels of dividends – and could act as a trigger for review.
||From 6 April 2016
||From 6 April 2018
|| No change
|| No change
|| Worse off at £5,001+
|| Now worse off at £2,001+
|| Worse off at £21,667+
|| Now worse off at £8,667+
|| Worse off at £25,250+
|| Now worse off at £10,100+
||Accumulated income - Worse off at £1+
Income distributed - No change
So what can advisers do ahead of April to help clients mitigate the effect of this change?
1. Ensure investments are held in joint names
Switching investments into joint names can help prevent clients paying excess tax. Take for example a retired couple with £100,000 invested in a UK equity income collective investment fund receiving £4,000 pa income distributions. If this was currently held in one name, no dividend tax would be due, but unless the investment is reviewed and transferred into joint names (a 50:50 split) from April, additional tax of £150 to £762 each year would be due (depending on tax status).
2. Maximise use of exempt wrappers
As equity investments held via an ISA, pension or VCT are exempt from dividend taxation, these should be maximised where available (subject to the client’s attitude to risk and capacity for loss). A couple could invest £40,000 in a UK equity income collective investment fund via a stocks and shares ISA this tax year and, at a distribution yield of 4%, receive £1,600 pa tax-free – a saving of between £120 and £610 each year. And don’t forget, clients can invest into their ISA each year thereafter, increasing the tax saving.
3. Split investments/income between spouses to minimise tax
This allows clients to hold specific proportions of investment (so not necessarily a 50:50 split), so they can utilise any dividend allowance and lower marginal dividend tax rates. Take, for example, a couple with £200,000 of jointly held UK equity shares and collective investment funds receiving £8,000 pa income distributions. Even though they may both have their dividend allowance available from 6 April 2018, if one is a HRT and the other a BRT, advisers may consider splitting the investment 25:75 in favour of the BRT, so that the dividend tax on the excess over their allowances is only taxed at 7.5% and not 32.5% – a saving of £500 each year (i.e. 25% tax difference on £2,000).
4. Rebalance investments between those taxed as dividends or interest
If clients have a mix of investments, with some taxed as dividend income and some as savings income (i.e. assets that generate interest), these should be reviewed to ensure that both the dividend and personal savings allowances are being utilised to provide up to £6,000 pa each of tax-free income this tax year. The latter allowance is £1,000 pa (BRT) or £500 (HRT) each and for a corporate bond collective investment fund with a distribution yield of 4%, this equates to an investment of up to £50,000 per BRT couple tax-free. Additionally, with tax rates on savings income being higher than those on dividend income, you may consider holding these investments in exempt wrappers ahead of equity investments.
5. Shelter equity investments within investment bonds
For individuals who have fully used their dividend (and other) allowances and trustees of discretionary trusts who don’t get them, tax-deferred investment bonds – specifically onshore – may be favourable for holding UK equity investments. This is because dividend income received by onshore investment bond life funds is exempt from corporation tax. This means the overall tax paid by a UK equity life fund could be substantially lower than the BRT credit given. So, a HRT investing in a UK equity fund via an onshore investment bond, has no ongoing tax liability and if they are a BRT on encashment, pay no further tax.
6. Review your platform
The use of appropriate tax wrappers and collective investment funds on platforms will be essential in helping advisers manage clients’ investments in a tax efficient way. As part of their due diligence, advisers may wish to consider features such as: pre-funding all payments in/out (including tax relief); family linking of accounts for lower overall charges; phased investment to help smooth market volatility; an option to protect the client from downside investment risk should they die in the early years; and a comprehensive range of independent investment/pension planners and tools to monitor a client’s portfolio in line with their attitude to risk/capacity for loss and objectives.
Dividend taxation is complicated and clients will need professional advice from qualified advisers in order to minimise tax and maximise returns, so this is a great opportunity to demonstrate to clients the value advisers can add.
Andy Woollon is a wealth specialist at Zurich UK