George Osborne’s July 2015 budget was seen as a blow to tax-efficient savings schemes such as individual savings accounts (Isas) and personal pensions. Osborne announced all taxpayers would be given a £5,000 annual tax-free dividend allowance in the 2016-2017 tax year. Since 85% of people don’t earn dividends worth more than this amount, the need to use Isas and pensions to shelter your investments from tax became more questionable, particularly given that capital gains also enjoy a fairly generous tax-free annual allowance (£11,100 in the current tax year).
But just over 18 months later, Philip Hammond’s 2017 budget is another reminder that assuming that the tax system won’t change is always a dangerous foundation for financial planning. Osborne’s successor has reduced the dividend allowance to just £2,000 a year, making pensions and Isas look attractive once again.
Osborne’s dividend allowance was introduced alongside a big hike in income-tax rates on such payments. While basic-rate taxpayers had previously paid nothing on dividends and higher-rate and additional-rate taxpayers had paid 25% and 30.56%, these rates went up to 7.5%, 32.5% and 38.1% respectively. Now that Hammond is reducing the tax-free annual allowance to just £2,000, many more investors will have to pay these higher rates.
Dividend-paying investments held within pensions and Isas, by contrast, carry no tax liability at all, however much income they generate. You don’t even need to report the income and capital gains to HM Revenue & Customs, meaning that the chopping and changing of tax rules creates much less of an administrative headache – there’s far less for you to keep on top of when working out your tax position each year.
This change shows the wisdom of making full use of your Isa and pension allowances while you can. Even if there’s no immediate tax benefit to putting money in a tax wrapper, you don’t know whether the rules will change in the future. MoneyWeek would not be at all surprised to see dividend tax rates rise further in future.