How to keep your dividends safe from the taxman

A series of changes to tax and allowances are kicking in from 5 April, meaning now is a good time to take stock of your investments, spring clean your portfolio and make the most of your ISA allowances - if you haven’t already done so this tax year. 

We look at why it’s worth shifting your investments into an ISA to protect your dividends from the taxman. 

How to protect dividend income from tax

The annual dividend tax allowance is being cut from £2,000 to £1,000 from April 2023, and then cut in half again to £500 from April 2024. 

The capital gains tax allowance is also being slashed from £12,300 to £6,000 in April 2023, and £3,000 in April 2024.  

Calculations by investment platform interactive investor show an investor with a £50,000 portfolio yielding 4% (£2,000 a year in dividend income), will go from paying no dividend tax to £88 from 6 April 2023, and £131 from April 2024. 

Meanwhile, a higher-rate taxpayer will face a tax bill of £338 from 6 April 2023, rising to £506 from April 2024 on dividend income of £2,000. 

“The shrinking dividend and capital gains tax allowances could provide the impetus for investors to invest through a tax efficient wrapper if they haven’t already done so,” says Myron Jobson, senior personal finance analyst at interactive investor. “Shifting investments into an ISA protects future gains and dividends from the clutches of tax.”

This process is known as a bed and ISA transfer.

The process involves selling and buying back shares, which could trigger a capital gains tax – so it’s important to make use of the larger allowance available this year. 

“Bed & ISA is a tried and tested route to wrapping existing investments to generate the long-term benefits of a tax-efficient Isa – which over the long term is likely to outweigh the charges that might apply,” says Jobson. 

Don’t forget about SIPPs

If you have used up your ISA allowance, you can put a tax-free contribution towards a self-invested personal pension (SIPP). 

This could be especially useful now given that the lifetime allowance has been scrapped following Jeremy Hunt’s Spring Budget. 

SIPPs qualify for the same upfront tax breaks as other pensions, but they come with more flexibility. You can pick and choose your own investments. Dividends are also tax-free within the pensions wrapper. 

Bear in mind – SIPPs cannot be touched until you’re aged 55, and from then on any withdrawals that exceed the 25% tax-free allowance will be taxed as income. 

So, although they might not be as convenient as ISAs, investors with extra cash can protect their dividends from the taxman by putting extra money into a SIPP while saving for retirement. 

How to maximise your ISA allowance 

Maximising your ISA allowance is more important than ever this year given the cuts to CGT and dividend tax allowances. 

Even if you don’t want to invest in a stocks and shares ISA, “you can always secure this year's allowance with cash now and take your time choosing when to invest your cash”, says Jobson. Just be sure to choose an investment platform that offers a good rate of interest on uninvested cash. 

Additionally, you can reduce taxable income by transferring assets between spouses. Both you and your spouse/civil partner can pay £20,000 into an ISA. 

“Couples can also effectively double gains and income they can make tax-free by using both their annual exempt amounts,” says Jobson. “Only married couples and civil partners can transfer assets tax-free, meaning those who aren’t could potentially trigger a tax liability.”

If you have several ISAs, consolidating them could “have added benefits beyond the convenience factor”, says Jobson. Transferring your ISAs might also save you money in fees. 

Finally, keep in mind that despite turbulent economic conditions, investing for the long-term yields better results than cash savings. 

“Nervous investors can drip feed investments monthly to help smooth out the inevitable bumps in the market, buying fewer shares when prices are high and more when prices are low – a process known as pound-cost averaging,” says Jobson.