Tax on Dividend Income 2023/2024

What are dividend tax rates and how much is tax-free?

Dividends are a form of payment made by companies to their shareholders out of the profits they have made. These payments are made on a per-share basis, meaning that the amount each shareholder receives is proportional to the number of shares they own. Unlike regular wages or salaries, dividends are paid gross, which means that no tax is deducted at the source. This allows shareholders to receive the full amount of the dividend payment upfront.

The concept of a 'dividend allowance' is designed to provide a tax-efficient way for individuals to earn income from their investments. For the 2023/24 tax year, the dividend allowance stands at £1,000. This means that individuals can receive up to £1,000 in dividend income without having to pay any tax on it.

It is important to note that if your total dividend income for the tax year is less than £1,000, you are not required to pay any income tax on that amount, regardless of your tax bracket.

This applies to basic rate, higher rate, and additional rate taxpayers alike. This tax-free allowance provides an incentive for individuals to invest in companies and benefit from the profits they generate without incurring additional tax liabilities.

In addition, any dividends received from investments in an ISA or pension such as a Self-Invested Personal Pension (SIPP) are free from income tax.

Outside of any tax-sheltered investments and the dividend allowance, the dividend tax rates are:

• 0% on the first £1,000 from dividends (this is called the Dividend Allowance)

• 0% if your total income is under the Personal Allowance (£12,570)

• 8.75% for basic rate taxpayers

• 33.75% for higher rate taxpayers

• 39.35% for additional rate taxpayers

In addition, any amount of dividend income falling within your income tax personal allowance is also tax-free. The personal allowance is currently £12,570 and first applies to non-dividend income – i.e. from earnings or pensions.

It is worth nothing that the Chancellor flagged in the November 2022 Autumn Statement that the personal allowance is set to remain at this level until April 2028.

What counts as dividend income?

UK shares and collective investments such as unit trusts and OEICs may pay dividends to investors. For UK shares it is clear cut – any income paid is classed as a dividend.

Yet for funds the situation is more complicated. If the fund holds 60% or more of its assets in fixed income investments such as bonds, then income paid counts as interest rather than dividend income. It is taxed accordingly at your usual rate of income tax, but the ‘personal savings allowance’ can mean all, or a portion of this, is tax free – there’s more information on this from the HMRC website here.

For funds with less than 60% in fixed income investments, any income will be classed as dividend. Investors should be aware that accumulation units (where income is reinvested automatically for you back into the fund) attract tax income tax on dividend or interest in the same way as income units (where income is paid out). Don’t assume that your return from a fund is all ‘capital gain’ rather than income because you are not actually receiving it. You do have to pay income tax on reinvested dividends.

How much dividend tax will I pay?

The amount of tax you will pay on dividends will depend on the ‘yield’ produced by your chosen investments that are outside of tax-efficient wrappers such as ISAs. This is the amount they pay out annually as a percentage of their share or unit price.

Different shares and collective investments funds pay out different amounts to investors. Multiplying the value of the investment by its yield will tell you roughly how much income you can expect to receive – and give you an idea of any potential tax liability.

For instance, a basic rate taxpayer has £10,000 in company XYZ and its yield is 4%. They can expect to receive £10,000 x 0.04 = £400 a year in dividend income. If they have also already used their dividend and personal allowances elsewhere, they would have pay tax of £400 x 8.75% = £35.

A possible dividend allowance reduction

The dividend allowance, the annual tax-free amount you can earn in share dividends, is very useful to investors. It is also an efficient way for self-employed individuals to pay some income to themselves via their own company. However, this important allowance is set to be cut from April next year.

Having been reduced from £5,000 to £2,000 in 2017, it is now set to disappear altogether, falling to £1,000 in 2023 and to just £500 in 2024. This potentially means lots more people will end up paying tax on their dividends and reporting dividend income to HMRC each year.

How to pay less tax on dividends

The reduction in the dividend allowance emphasises the need to use tax-efficient ISA accounts, or pensions, to house investments as far as possible. Any income is tax free, as are any profits. Using as much of the annual ISA allowance of £20,000 each year as you can means it is possible to build up a significant portfolio of investments sheltered from tax, plus you can reduce or eliminate the fiddly administration involved in tax returns or HMRC reporting.

If you are married or in a civil partnership, you can also consider splitting income producing assets, either by holding them in joint names or allocating them to the partner with the lower income and tax liability.

You can also consider how you arrange your asset types. For instance, it can make sense to prioritise your ISA allowances for dividend-producing investments rather than cash. For some individuals, the personal savings allowance applied to interest on cash is significantly higher than the dividend allowance, at up to £5,000 for the ‘starter rate’, and the return on cash is often lower than that from dividends. However, the situation will depend on tax position, the mix of assets you own and how much you get paid in interest on cash.

Finally, if you have earned income from employment or self-employment and want to reduce your tax bill more generally, you could consider additional pension contributions. These can have the effect of reducing your earned income so that less of your income falls into higher tax bands. Please note that income tax rates and bands are different in Scotland.