THE Chancellor announced a change to the way dividends are to be taxed as part of the emergency Summer Budget.
17:35, Thu, Jul 9, 2015 | UPDATED: 17:51, Thu, Jul 9, 2015
Dividend tax is changing
From April 2016 the new rules are set to come into effect and cut an additional £2.5billion out of investor's income through tax.
At the moment basic-rate tax payers are not required to pay tax on dividends.
But under the new rules that will change.
Dividends are annual cash payments made to holders of certain shares, they provide a vital source of income to many pensioners who rely on savings in retirement.
Many people pick certain shares solely based upon their dividend payouts.
How the new system will work
Under the proposed changes, all taxpayers will have a new tax-free dividend allowance of £5,000 a year.
After this tax is to be charged at new rates that are 7.5 per cent higher than current levels.
The overall tax rate will depend on your income tax rate band.
If your dividend income pushes from one income tax band into the next, you will then pay the higher dividend rate on that portion of income.
The table below compare this tax year with next.
Dividend tax rates
Non-taxpayers 0 per cent 0 per cent
Basic rate taxpayer 0 per cent 7.5 per cent
Higher rate taxpayers 25 per cent 32.5 per cent
Additional rate taxpayers 30.6 per cent 38.1 per cent
Source: Hargreaves Lansdown
Danny Cox, chartered financial planner, Hargreaves Lansdown, said: “The new dividend taxation rules are definitely simpler but are also costly for some.
"Investors need to navigate their way around the new rules carefully to avoid tax rises.
"Apathy is the investor’s enemy and people should fully use their tax shelters such as an ISA, even if they think their income or gains will currently fall within tax-free allowances.
"You just never know when things might change in the future so it’s best to bank your tax breaks while you still can.”
How to beat dividend tax rises
• Use your ISA allowance now
Unlimited dividends can be withdrawn from an ISA tax-free, which is why sheltering taxable investments in the accounts will become all the more important, says Hargreaves Lansdown.
• Consider a SIPP
SIPPs (Self-Invested Personal Pensions) also have the benefit of tax-free dividends.
For retirement savings where money is not needed until age 55 the tax benefits of SIPPs make it a good option for many.
• Maximise your annual tax-free dividend allowance
Married couples and registered civil partners should spread their taxable portfolios between them to make full use of each person’s allowance.
Couples should also make full use of personal allowances and basic rate tax bands, where applicable, so that taxable dividends are paid in the name of the spouse who pays the lowest tax rates.
• Be clever with yield
A diverse portfolio will have shares and funds that generate different levels of dividend income yield.
Hargreaves Lansdown recommends sheltering those that generate the highest yields in an ISA to maximise the dividend income tax allowance.
• Reduce other income
Dividend tax is linked to the rate of income tax you pay, so look to move down a tax band where possible.
For instance, in some cases taxable income for a particular year could be reduced.
Think about transferring income bearing assets such as cash deposits to a lower earning spouse, or deferring withdrawals from a drawdown pension until a new tax year.
• Invest in VCTs
For taxpaying, sophisticated investors, happy to take higher risks, Venture Capital Trusts (VCTs) generate tax-free dividends, points out Hargreaves Lansdown.
These tax-free dividends will be payable in addition to tax-free dividends from an ISA and tax-free dividends within the new £5,000 Dividend Allowance.