In the autumn statement back in late 2021, Chancellor Rishi Sunak announced a big shake up to national insurance, which included increasing national insurance contributions for employees and those who are self employed to help fund the NHS and social care.
The government also took a swipe at business and investment owners who receive some (or all!) of their income through dividends, which until 6th April 2022 avoided national insurance contributions.
As a result, dividend tax changes were announced and the taxes paid on dividends will increase on 6 April 2022.
Here’s everything you need to know, and how, with effective planning, you can best manage the changes.
How are dividends taxed?
You pay tax on your dividend payments at a rate in line with your income tax band, which is where you’ll pay tax depending on how much other income you have, and at whichever tax bracket the dividend income falls into.
If you pay basic rate tax, you currently pay 7.5% tax on dividends. If you’re in the higher rate or additional rate tax bands, you pay 32.5% and 38.1% tax respectively.
But you only pay tax on dividends over the dividend allowance.
What is the dividend allowance?
The dividend allowance is a tax break for the first £2,000 of dividends you receive in a tax year. It means you can earn up to £2,000 in dividends tax free each year – a pretty sweet deal if you have investments in shares or a limited company that can pay out dividends!
Dividend tax changes – increase explained
The dividend tax changes are designed to target those who earn most of their money through dividends, and therefore pay little to no national insurance on their whole income.
From 6 April 2022 tax on dividend income will increase by 1.25% at each discrete tax rate. You may have heard about this as part of the government’s plans to support the NHS, health and social care following the impact of the coronavirus pandemic.
That means that the new rates will be as follows:
- Basic rate: 8.75% (was 7.5%)
- Higher rate: 33.75% (was 32.5%)
- Additional rate: 39.35% (was 38.1%)
The good news is that the tax free dividend allowance isn’t changing, so these tax rates are only applied to dividend income over £2,000. As you can see, even those new rates are lower than the rates for pay through a PAYE scheme under income tax rules.
Dividend tax planning opportunities
The incoming dividend tax changes will have an impact on shareholders and business owners/directors who pay themselves in dividends rather than wages, and also for general investors who have a portfolio of dividend-yielding investments outside of a tax umbrella, like an ISA or pension savings scheme.
So, as a shareholder, director or investor, what can you do to plan effectively for the tax increase? Here are three strategies to consider:
1 – Pay a higher dividend in the current tax year
If your business is in a position to pay a dividend before the end of the tax year, but perhaps you were waiting until the new tax year, then the dividend tax changes that are due to arrive on the 6th April may make it more beneficial to declare a dividend on or before the 5th April 2022 to ensure you benefit from the lower tax rate. It could result in significant savings in tax year 2022/2023!
This measure is only appropriate for companies that intend to continue trading as they are for the foreseeable future. If you’re thinking of selling the business soon, be aware that an unusually high dividend payment could impact the value of your business.
Similarly, if you’re thinking about selling or closing down the business, there may be more tax efficient strategies to plan for the impact of capital gains tax.
2 – Contribute to your pension
A great tax-efficient solution for directors is to invest some of the profits from your business into a pension.
Moving profits from the income you draw into your pension has a couple of benefits. Of course, it’s always handy to build your nest-egg for the future and save for your retirement. But it’s not simply a future benefit. Contributing to your pension now will immediately lower your taxable income, and reduce your tax bill.
Your limited company can contribute into your pension without the annual limit that you personally are restricted to, so if you’ve been putting off saving for retirement this might be the best time to start. It’ll help reduce the businesses corporation tax bill too!
3 – Use an ISA
ISA’s are tax free savings accounts, and they can be in cash or stocks and shares so they’re a great way of saving without being taxed.
One final strategy in your quest to save tax is to consider is transferring investments that pay out dividends into ISAs (where it is possible to do so). Dividends received from shares in ISAs are still tax free, and they won’t contribute to your taxable allowance!
Dealing with dividends in a tax-efficient way can be complicated. The best solution for you will depend upon your personal circumstances and it’s a good idea to seek advice from a specialist to make sure you get it right.
If you’d like to find out how to make the most of your tax planning opportunities, let’s talk!