Reinvesting dividends from investments is an obvious way of long term investors building wealth for when they retire.
Then when they stop working the dividends paid out can be an excellent form of income to supplement pensions. Not only do many dividends pay out more than deposit based accounts, but there is also a possibility that if profits of the companies you are investing into increase then so can the dividend payments.
However from April 2016 there will be significant changes to dividends. The chancellor is proposing that the first £5,000 of dividend income in each tax year will be tax free. Sums above that will be charged at 7.5 per cent for basic rate taxpayers, 32.5 per cent for higher rate tax payers and 38.1 per cent for additional rate tax payers. No tax will be deducted at source with tax payers using self assessment to pay any tax due.
These changes will make life better for most investors and is expected to encourage more people to invest. But the changes will hit wealthier and large scale investors after they have used the £5,000 allowance up. For example standard rate tax payers with a reasonable size portfolio will pay the 7.5 per cent tax whereas previously they paid effectively nothing. Also the higher rate and additional tax payers will both be worse off with the new regime paying approximately 7.5% more dividend tax.
The most obvious solution to these tax grabs would be to transfer shareholding into ISAs.
Although with ISA allowances at £15,240 per tax year people with significant holdings may find that it could take a long time to transfer a portfolio totally into ISA’s. Also care needs to be taken when doing this to ensure that when selling investments and then purchasing again to put into ISAs that you are not opening yourself to further tax liability. This is possible if you bought a share very cheaply and then sold to buy an ISA and it has performed well the sale could generate a capital gain. There are also other potential strategies that you could use to combat this new tax for those affected. So it’s always worthwhile consulting an IFA to ensure you have the right tax vehicle and the right level of risk to achieve your goals.