Good reads from around the Web.
I still get comments incorrectly – and often indignantly – claiming there’s a 10% tax paid on dividends that holding shares in an ISA “no longer” protects you from.
I still read media advice saying the same thing.
Not as often as before, admittedly, mainly because the seed of this misconception was abolished over a decade ago and many of those who bore a grudge have literally moved on (/away!)
But the myth lingers, so I was glad to AIC boss Ian Sayers addressing it this week.
Sayers writes:
Trawl the internet and you will come across many statements like:
“Apart from dividend income (paid with 10% tax already deducted which can’t be reclaimed), the rest of the income is tax-free”
“Dividends from equities are paid after a ten per cent tax credit has been deducted and ISA investors cannot reclaim this.”
The problem is that these statements are untrue.
Now, I am not criticising anyone for not getting this quite right. The tax position of dividends is not only complicated but also counter-intuitive. My concern is not simply this is confusing investors, but may be leading some to make the wrong investment decisions, and even pay tax that is not due.
I am also not criticizing anyone who hasn’t read my articles on UK dividends and ISAs for not getting this right.
However if you have read widely and yet you still state the opposite in our comments and wonder why I delete you rather than continue to breath life into this hoary old half-dead Internet-enabled horse, now you know. 🙂
- The AIC has produced a short and clear guide debunking the whole “10% tax” myth, which you can download as a PDF.
Something that is affected by the 10% muddle is your income tax liability.
It’s complicated, but the AIC guide makes a good fist of explaining it.
Now for an afternoon of rugby drama!
From the blogs
Making good use of the things that we find…
Passive investing
- Which interest rates affect bond prices? – Oblivious Investor
- Don’t stop investing during recessions – AWOCS
- How competition [eventually!] lowers costs – Abnormal Returns
Active investing
- CAPE and the Ship of Theseus conundrum – Value Perspective
- 10 UK oil stocks affected by the budget – iii Investor
- Time periods and US equity returns – Irrelevant Investor
- The rising risks of a stock market crash – Sigmund Holmes
- Everyone hates commodities – The Short Side Of Long
- Unpicking the “new tech bubble” – Musings on Markets
- A new “total return EPS index” [Technical, nerdy but interesting] – Philosophical Economics
Other articles
- Investing notes to my 21-year old self – DIY Investor (UK)
- The middle-class is deluded – Simple Living in Suffolk
- We all need a mountain to climb – The Escape Artist
- Public sector pension fund fury – Keeper of the Cauldron
- What’s your time worth? [Good US read, ignore Roth bit] – Can I Retire Yet?
Product of the week: Fancy an old-fashioned 110% mortgage? There’s a catch – you have to buy an unwanted house in Spain, reports The Telegraph.
Mainstream media money
Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1
Passive investing
- Bogle’s latest attack on ETFs [Search result] – FT
- Malkiel: No free lunch with Smart Beta – ETF.com
- Is dumb money now going into Smart Beta? – Bloomberg
Active investing
- The global flight from coal – Slate
- On emotional intelligence – Institutional Investor
- In praise of short sellers – New Yorker
- Global dividend stocks the top pros are buying – Morningstar
- The dark side of strong bond returns – WSJ
Other stuff worth reading
- Why penny stock gurus are super-rich and I’m not – Bloomberg
- Making the best of the new savings tax breaks – Guardian
- How the “HMO Daddy” gets 35% yields [Video] – Telegraph
- Does your house earn more than you? – ThisIsMoney
- Lifetime allowance a mess in the making [Search result] – FT
- Corporations are becoming intangible and virtual – Bloomberg
- The anti-bucket list – Zen Habits
Book of the week: Michel Lewis reflected on the aftermath of Flash Boys
Like these links? Subscribe to get them every week!
- Note some FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [↩]
What about dividends received from other countries? Is there a good overview where the 10% credit is given? Sounds like you get relief from double taxation (corporate/individual) when you invest in the UK but not (directly) in other countries. Also, when you invest in a UK fund that invests in foreign companies you get the relief even though the corporate tax is not paid in the UK. Or is this solved through dividend withholding taxes? Can someone shed I light on the international aspect?
For those with curious minds, there is more logic to the UK’s tax regime than is immediately apparent. The funny rates applying to dividends are designed to ensure that the net-of-tax treatment of a given amount of income/profit is the same whether it is paid directly (e.g. as salary) or via a company. £1000 of profit, less 20% corporation tax (tax of £200, £800 left), then paid out as a ‘net’ dividend (of £800, plus a £80 tax credit), then with say higher rate 25% dividend tax (£200 tax, leaving £600) deducted, results in the same final total as would supposedly be received if you just received £1000 as income and paid 40% higher rate tax on it – i.e. £600.
I don’t know why the tax credit is only 10%, not 25% (as it theoretically should be), but presumably this is to cap the amount of tax reliefs applicable to dividend income.
Thankfully, the UK policymakers ignore national insurance when they set dividend taxes, which means that it is significantly better to be paid by dividending out fee income than to go through PAYE.
I have made this mistake, and I’m not very apologetic about it, because I’m a dummy and I still don’t understand it, even with the ‘clear’ pdf explanation… why not just say – ‘here’s your dividend. there’s no tax on it’?
“How the “HMO Daddy” gets 35% yields”: I read that article this morning. The answer is that he doesn’t. All they did was divide an annual rent by a capital cost, ignoring his running costs. Since he has 40 employees, we may take it that his running costs are not negligible. Still, the chap is a blowhard and is probably happy that the readers swallow such guff. It did cross my mind that he might be planning to sell the business.
Alternative headline: Running a business can be quite profitable if you are good at it.
Haha yes it is notable that none of the various explanations are comprehensible
Pity the AIC can’t even spell position correctly in their pdf.
I thought I had understood this but then turned to Invesco Perpetual’s explanation in their Guide to ISAs: “The income from interest-bearing assets such as gilts and corporate bonds are also tax free, but for investors holding equities that pay dividends the situation is slightly different. A tax credit of 10% is deducted at source from dividends, which investors cannot reclaim. That means that basic and non-taxpayers don’t see any income tax benefit from the ISA wrapper – but it does save higher-rate taxpayers from paying a further 22.5% tax on dividends.”
And became confused once more…
Question:
If I have an accumulation fund i.e. Fidelity Index UK Fund Acc.
Will dividends get “paid to the balance of my fund” or will the value of the fund simply increase over time taking into account dividend reinvestment? Hence the price difference between the same fund one being an accumulator and the other a non-accumulator?
Thanks,
Sam
Here is the problem I have with this. I am a 20% tax payer (on pension and drawdown SIPP). If I hold shares in a separate stock account I receive dividends at zero tax (after the notional credit and special 10% rate bull$hit). However, if I hold those shares in my drawdown pension SIPP I get the dividend tax free when I receive it – but then I get taxed when I draw the income out. So it appears that it would be BETTER to hold income stocks OUTSIDE a personal drawdown pension. No-one has mentioned this. Have I got it completely wrong?
Good links again, thanks for them. I really enjoy Michael Lewis and all the articles that he’s published via Vanity Fair are excellent, especially those about the 2008 crisis and how it affected places like Ireland, Iceland and California. They can all be found via Google. To be fair, I wasn’t that impressed with Flashboys, but it was still worth reading.
Many thanks for the mention. Much appreciated. 🙂
@Martin — Witholding tax is it’s own world of pain. Other countries don’t care about our notional tax credits.
http://monevator.com/withholding-tax-on-dividends/
@InvestorGeek — Yes, good explanation, and I’ve also found it makes more sense to look at it through a ‘tax scaffolding’ prism than a private investor one.
@M — Effectively that is what happens if you’re a basic rate tax payer. If you’re a higher rate tax payer, then you pay an effective rate of 25%. The confusion comes because people waffle on about the 10% you (supposedly) can’t reclaim in an ISA. InvestorGeek’s explanation in these comments gives a good summary of why the system exists. (It helps I think not to think it was designed for “us” 🙂 ).
@IngenueInvestor — They are correct that (in the short term, from a pure income tax perspective) there’s no benefit to basic rate taxpayers holding shares in an ISA. There’s no need for them to conflate it with the 10% rate though. And it saves higher-rate tax payers 25%, not 22.5%. So somewhat bizarrely it seems even that author doesn’t understand how it works.
@Sam — Seek answers to your questions here: http://monevator.com/income-units-versus-accumulation-units-difference/
@Richard — I can’t give tax advice that seems to be personal advice. However I can say that basic rate and non-taxpayers do pay no further tax on dividends.
With respect to the pension, one gets the tax relief going in, not coming out, so the benefit would have (presumably) been received at that point, while you were paying tax.
Pensions are really tax arbitrage vehicles with perks (such as the tax free lump sum) otherwise they are mathematically equivalent to ISAs:
http://monevator.com/pensions-versus-isas/
(Note: That’s an old article, I haven’t checked but the pension specifics will be somewhat out of date).
@Jim McG — Yes, he gets a lot of stick from investor/financial types but really he’s the only person who tells finance sector tales with any consistent aplomb, without excessive dumbing down.
@Cerridwen — You’re welcome!
Richard: to make this more concrete, let’s suppose you are always a basic-rate taxpayer, and also that you never make big enough capital gains to pay any capital gains tax. then if you have £1000 in shares in a taxable account, which grows due to either dividends (which are reinvested), or capital gains, or a bit of both, you won’t pay any tax on the dividends or gains. so after a few decades, perhaps your account has doubled in value, and then you have £2000, and no tax is due on it.
what if you bought the shares inside a pension instead? you’d have got 20% relief on the contributions, so you would have started with £1250 inside the pension (£1000 contribution + £250 tax relief). it would have doubled, due to dividends and capital gains, to £2500. then you’d take out 25% tax free, i.e. £625; and you’d pay 20% tax on the remaining £1875, i.e. £375 tax, so your net proceeds would be £625 + £1500 = £2125.
the pension is marginally ahead, which is entirely due to the tax-free lump sum.
that is just 1 scenario. there are circumstances in which a pension can be worse, e.g. that might well be the case if you were a basic-rate taxpayer when you contributed to a pension, but a higher-rate taxpayer when you drew the pension. but such circumstances are quite rare (at least unless you expect that income tax rates will be much higher when you draw your pension – not something we can calculate now). there are also a number of (more common) circumstances in which a pension is better by a bigger margin, the main ones being: matching employer contributions, higher-rate relief on contributions, or a salary sacrifice pension scheme.
(naturally, this does constitute advice. would anybody take advice from an old sock, anyway? :))
@grey gym sock. Thank you very much for the clarification. It’s been doing my head in for ages. As I suspected pensions are really not as tax efficient as often supposed. I’m trying to live off dividend income with no tax on divi’s until I exceed my basic rate allowance, and with careful use of capital gains my wife and I can earn £103,000+ per annum between us and pay no tax. Happy days.
(That’s made up of 10,000 personal exemption + 31,750 basic rate allowance of which divi’s are exempt + 10,000 capital gains allowance)
well, in the scenario when all your income in retirement is dividend income, then you have probably mised a trick by not using a pension, because the first 10,000 of pension income would be set against your personal allowance. even with only 20% relief on pension contributions, if there is 0 tax when drawing the pension, then you’ve multiplied everything you pass through a pension by a factor of 1.25.
so it might be more tax-efficient to aim for roughly 10,000 income from a pension, + 31,750 dividends, + 10,000 capital gains.
however, if you are going to get a state pension of (say) 7,000, that uses a lot of your allowance, so you might aim for your drawdown pension paying 10,000 before you reach state pension age, and 3,000 after.
(this ignore ISAs. i assume you’re already filling them, and we’re just talking about what is left over.)
@grey gym sock — Thanks for working through the numbers here. 🙂
@grey gym sock Again thank you for this detail it really has clarified things for me. (I do have a full state pension and a small pension which uses up my personal allowance and I do fill up my ISA’s) But moving away from my particular circumstances the point that I want to make, and which is far from discussed on most financial blogs and websites, is that with a little care most tax can be avoided in retirement up to a significant income. The finance industry rarely makes this clear in its headlong dive into pension and managed fund advice. (I use the word advice generously).
Thank you again for your lucid and informative explanations.
Brilliant, your article link on the difference between inc & acc cleared my question up.
Thanks again,
Sam
“with a little care most tax can be avoided in retirement”: true. But as we get older and more dimwitted it’s helpful if the actions required to avoid tax are minimal, achieved by e.g. keeping almost everything in ISAs. Though I think the new tax-free interest on savings provisions will prove pretty easy to use, unless we get a new Chancellor determined to muck them up.