For years now, dividend tax rates have been increasing. In addition investors have been hit with a massive reduction in the already miserly tax-free dividend allowance.
Let’s run through the current dividend tax rates and allowances. We’ll then consider how we got here, and what you can do about it.
Dividend tax rates for 2023-24 and 2024-25
The rate of tax you’ll pay on your dividends depends on your income tax band.
UK dividend tax rates are currently:
- Basic rate taxpayers: 8.75%
- Higher rate taxpayers: 33.75%
- Additional rate taxpayers: 39.35%
But note that depending on your total earnings – and where it comes from – you could pay tax at more than one rate on your income.
These higher dividend tax rates went into effect on 6 April 2022. At that point the tax rate for each band was hiked by 1.25 percentage points.
A pledge to reverse the hike was made with the Mini Budget of 2022. But this was scrapped by replacement chancellor Jeremy Hunt when he took office.
I hope you’re keeping notes at the back.
We’re talking about dividends paid outside of tax shelters. Dividends earned within ISAs and pensions are ignored with respect to tax. Adding up your dividends for your tax return? Don’t include dividends paid in ISAs or pensions. Forget about them when it comes to tax. (Enjoy them for getting rich.)
The tax-free dividend allowance 2023-24 and 2024-25
As of 6 April 2023, the annual tax-free dividend allowance was reduced to £1,000.
It’ll halve again in April 2024 to £500 for 2024-25.
Dividends you receive within the tax-free dividend allowance are not taxed. But breach the allowance and the rest is taxed according to your income tax band.
Like other tax allowances such as the personal allowance [1] for income tax, the dividend allowance runs over the tax year. (From 6 April to 5 April the next year).
The £1,000 dividend allowance means you only automatically escape dividend tax on the first £1,000 of dividend income. This level of dividend is tax-free, irrespective of how much non-dividend income you earn and your tax bracket.
As already noted, things get worse from April 2024. From then you’ll only be able to receive £500 before you start paying tax on your dividend income.
(You read somewhere about the old Dividend Tax Credit system? It was scrapped years ago.)
What are dividends?
Dividends [2] are cash payouts made by companies:
- You may be paid dividends by shares listed on the stock market or by funds that own them.
- You might also be paid dividends from your own limited company, as part of your remuneration.
Dividend tax only comes into the picture on dividends you receive outside of a tax shelter.
Using ISAs [3] and pensions is key to shielding your income-generating assets from tax [4] for the long-term.
What tax rate will you pay on your UK dividends?
If your dividend income exceeds the tax-free dividend allowance, you’ll pay tax on the excess.
This liability must be declared and paid through your annual self-assessment tax return [5].
For example, if you received £6,000 in dividends, then tax is potentially charged on £5,000 of it. (£6,000 minus the 2023-2024 £1,000 tax-free dividend allowance).
As we said, the rate you’ll pay depends on which tax bracket [1] your dividend income falls into.
Beware of being bounced into a higher tax band
If you own dividend-paying shares outside of an ISA or pension, then the dividends may add substantially to your total income. Perhaps enough to push you into a higher tax bracket.
To avoid taxes reducing your returns [4] you should invest within ISAs or pensions.
If you own funds outside of tax shelters, you could also owe tax on reinvested dividends [6]. Choosing accumulation funds [7] doesn’t spare you the tax rod – unless they’re safely bunkered in your tax shelters.
Watch out for withholding tax on dividends
If you’re paid dividends from overseas companies, you may be charged tax on them twice. Once by the tax authorities where the company is based, and again by Her Maj’s finest in the UK.
You may even pay this withholding tax on foreign dividends held within an ISA or pension.
However there are reciprocal tax treaties between the UK and other countries. These can at least reduce the total amount of dividend tax you pay.
Your broker should take care of this for you.
Some territories do not charge withholding tax on dividends received in a UK pension. The US is the most notable one. (This doesn’t apply to ISAs. Choose where you shelter your US shares accordingly.)
Again, make sure your platform is paying you any US dividends in your pension without any tax having been charged.
It can all get a bit fiddly. See our article on withholding tax [8].
Why was the old dividend tax system changed?
Then-chancellor George Osborne revamped UK dividend taxation in the Summer Budget of 2015.
He apparently wanted to remove the incentive for people to set themselves up as Limited Companies and then use dividends as a more tax-efficient way to get paid, compared to salaries.
Osborne also said the changes enabled him to reduce the rate of corporation tax.
But whatever his intentions, as we’ve seen today’s regime applies equally to dividends received from ordinary shares.
Even worse, the initially fairly-generous dividend allowance of £5,000 – designed to avoid small shareholders being taxed on legacy dividend-paying portfolios – will be just £500 from April 2024.
Osborne’s problem with dividends
The old system of tax credits on dividends was designed roughly 50 years ago.
Corporation tax rates then were above 50%. Add in personal taxation, and some people saw the income earned by the companies they held taxed by 80% or more.1 [9]
Since those ancient days, however, corporation tax rates have fallen.
And the government wanted to simplify things.
The good news was the confusing tax credit system got the chop.
The bad news was we now pay much more tax on dividends.
The changes threw a spanner into the works of some older wealthy people. They had based their portfolios (and their retirement plans) on how dividends were previously taxed.
That’s because before 2016 the implicit ‘dividend allowance’ was as much as £31,786, so long as your income from non-dividend sources was below your personal allowance [1].
So some people held huge income portfolios outside of tax shelters. At the time this was fine because of how much you could get in dividends before taxes kicked in.
How things have changed!
Some people saw their dividend tax bills soar
Most small investors have not been hit by changes to dividend tax. Most of us hold our shares within ISAs and pensions nowadays.
However there are exceptions.
Small business owners paid a dividend by their limited companies now pay more tax. Salary-sized dividends chew straight through today’s puny dividend allowance.
There also exists that dwindling cohort of older investors who built up a big portfolio of income shares outside of ISAs and pensions. They’re paying much more tax too.
Always use your tax shelters
For years I urged [10] these dividend investors to move as much money as possible into ISAs. They could do this by defusing gains [11] to fund their ISAs, for instance.
The ISA allowance is a use-it-or-lose-it affair. You must build up your total capacity [12] over many years.
Yet inexplicably to me, some argued – even in the Monevator comments [13] – that there was no point.
Dividends were not taxed until you hit the higher rate band, they said. So why bother?
That was true under the old system. And maybe there was a harder choice to be made if you also had massive cash savings. Because when interest rates were higher, there was more competition for your annual ISA allowance. (A dilemma that’s returned again with interest on savings accounts back around 5%.)
But the truth is taxes on dividends were always liable to change. And eventually they did.
At that point, the people who had declined to move some or all of their portfolios into ISAs – just to save a few quid – were hit with big tax bills.
I hate to say I told you so. (Truly – I write a blog to help people.)
ISA sheltering costs nothing. Even back then there was at most a trivial cost difference with an ISA versus a general account [14]. Nowadays there’s usually none.
Get any non-sheltered portfolios into an ISA (and/or a SIPP [15]) as soon as possible, if you can. Not just to avoid dividend tax, but also to shelter from capital gains taxes [11] and other future regulatory changes.
Note: I’ve removed talk about the old way UK dividends were taxed in the comments to reduce confusion. We have to let go! But the discussion may still refer to old (or incorrect) dividend tax rates and allowances. Check the dates if unsure.
- Remember, companies paying you a dividend have already paid corporation tax on their profits. That’s before any dividend is paid to you. [↩ [20]]