Tax on share dividends to increase by 1.25%. Here’s what it means for investors

The government has announced a dividends tax shakeup. So if you’re an investor, what does it mean for you? Karl Talbot takes a look.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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The government has announced a 1.25% increase in the tax on share dividends that will apply from April 2022. The news comes at the same time as it was announced that National Insurance contributions will increase by 1.25% next year.

The government says the rises will help fund health and social care in England. Both announcements are subject to a vote in the House of Commons.

So if you’re an investor, what does the new tax on share dividends mean for you? Here’s what you need to know.

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How much tax is currently paid on share dividends?

If you’re an investor, you currently get a dividend allowance of £2,000. So, if you receive dividends worth £2,000 or less, you don’t have to pay any tax on them.

For dividends of more than £2,000, the amount of tax you pay depends on your income tax band. This is unless your investments are held in an ISA, in which case your dividend payments remain tax free.

For non-tax-efficient investments, you must pay 7.5% tax on any dividends over £2,000 if you’re a basic rate taxpayer. If you’re a higher rate taxpayer, you must pay 32.5%, and it’s 38.1% if you’re an additional rate taxpayer.

You can find more information on income tax bands on the gov.uk website.

What are the changes to dividends tax?

From April 2022, the government is implementing a 1.25% rise in the tax on dividends to help fund social care. Analysts expect that the move will raise up to £600 million, with the majority of payers coming from the top 10% of households. 

The new tax will not, however, apply to investments held within an ISA. 

Why has dividends tax increased?

With a National Insurance hike of 1.25% also announced, many analysts feel that the dividends tax is a way for the government to show that it is keen to increase taxes on asset holders as well as those who rely on a working income.

Critics of the National Insurance hike have repeatedly pointed to the fact that it will not apply to most pensioners, landlords or those living off income from assets, suggesting that only those relying on a working income face the burden. 

National Insurance, by definition, is also a regressive tax, meaning that an increase disproportionately impacts those on lower incomes. That’s because the amount of contributions you have to make, at a percentage level, decreases at higher incomes.

However, critics of the dividend tax rise consider it a token gesture. That’s because the 1.25% rise won’t apply to investments held in an ISA.

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How has industry reacted? 

Commenting on the changes, Tom Selby, head of retirement policy at AJ Bell, says that investors should now take the time to examine their portfolios in order to ensure they aren’t inadvertently paying more tax than they need to.

He explains: “The increase in dividend tax means people investing outside tax-sheltered wrappers like pensions and ISAs should review their portfolios to make sure they are making as much use as possible of their annual contribution allowances to keep their tax bills as low as possible.” 

Will the tax increase definitely go ahead?

MPs will vote on the government’s health and social care plan, including the planned dividends tax rise, on Wednesday 8 September at 7pm.

While a number of cross-party MPs do not approve of the proposals, the policy is expected to pass through the House of Commons.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

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