How to reduce a Dividend Tax bill as the number of people paying doubles in 3 years

In 1602, the Dutch East India Company became the first-ever publicly traded business and began issuing dividends – a portion of the company’s profits paid to shareholders. According to Investment Week, shareholders received a shipment of nutmeg and pepper as payment.

Over 400 years later, dividends – now paid in the form of cash or additional shares – have evolved to become an integral part of the stock market. As an investor, you might hold dividend-paying shares in your portfolio.

The regular payments you receive could help you generate an income to fund your lifestyle. Alternatively, you might reinvest dividends to grow your wealth faster.

Regardless of how you utilise dividends, you may need to consider the tax you could pay on them. This is because IFA Magazine reports that the number of people paying Dividend Tax has doubled in the past three years.

Read on to learn why this is, and three ways to potentially mitigate a large bill.

The Conservative government cut the Dividend Allowance twice in the past two years

One of the main reasons that more people are paying Dividend Tax is that the previous Conservative government reduced the threshold at which you start paying.

Normally, you don’t pay tax on dividend income that falls within your Personal Allowance of £12,570 in the 2024/25 tax year. Additionally, you have a “Dividend Allowance” of £500.

You could pay Dividend Tax on any payments that exceed these thresholds and the rate you pay depends on your Income Tax band. In 2024/25, you could pay:

• 8.75% if you’re a basic-rate taxpayer
• 33.75% if you’re a higher-rate taxpayer
• 39.35% if you’re an additional-rate taxpayer.

However, the Dividend Allowance was previously much higher than it currently is. In April 2023, the government reduced the threshold from £2,000 to £1,000. The following year, in April 2024, they dropped it again to £500.

As a result, IFA Magazine reports that around 1.8 million investors paid Dividend Tax in 2020/21, but this increased to almost 3.6 million by 2024/25.

This means that a fifth of all higher-rate taxpayers are expected to pay Dividend Tax this year, with an average bill of £5,379. Additional-rate taxpayers could pay an average of £32,578.

Rachel Reeves could announce further changes to Dividend Tax in the upcoming Budget

Prime minister Keir Starmer and chancellor Rachel Reeves have both suggested that the government will announce tax increases of some kind in the upcoming Budget on 30 October 2024.

For example, Reeves spoke of a £22 billion “black hole” in the public finances, and the prime minister said the Budget would be “painful”.

We don’t know what tax changes the government will announce yet, if any. However, the chancellor has repeatedly said she won’t increase Income Tax, National Insurance (NI), or VAT. As a result, there are fears Labour could change Inheritance Tax (IHT), Capital Gains Tax (CGT), or Dividend Tax.

For example, the government could further reduce, or even remove the Dividend Allowance. Alternatively, they might increase the rate at which you pay Dividend Tax.

This could mean that you’re more likely to pay the tax in the future.

Fortunately, there are three ways you could potentially mitigate a large bill.

1. Use your full ISA allowance

Investing in a Stocks and Shares ISA may be an effective way to mitigate Dividend Tax. This is because you don’t pay Income Tax, CGT, or Dividend Tax on interest or investment returns from wealth in an ISA. You also don’t pay tax when withdrawing your savings.

In 2024/25, you can contribute up to £20,000 across all your ISAs. Using as much of this allowance as possible could help you reduce the Dividend Tax you pay.

2. Plan as a couple

If you and your partner plan as a couple, you may be able to use both of your Dividend Allowances. For example, if you’ve used your allowance but your partner hasn’t, you could transfer some of your dividend-paying shares to them.

This might reduce the portion of your dividend income that exceeds the Dividend Allowance, meaning you pay less tax.

Additionally, you both have your own ISA allowance each year. This means that you can effectively invest up to £40,000 between you without paying Dividend Tax if you make use of both allowances.

3. Invest in your pensions

If you have used your ISA allowance and want to make further tax-efficient investments, you could consider increasing your pension contributions. This is because you don’t pay CGT or Dividend Tax on returns from wealth in your pensions.

Additionally, you can normally make contributions up to your Annual Allowance of £60,000 (or 100% of your earnings, whichever is lower) in 2024/25 without an additional tax charge. If you’re a higher earner or you have already flexibly accessed your defined contribution pension, your Annual Allowance could be lower.

You benefit from 20% tax relief automatically and if you’re a higher- or additional-rate taxpayer, you could claim another 20% or 25% through self-assessment.

As such, increasing your pension contributions could be an effective way to mitigate Dividend Tax and grow your wealth for the future.

These are all effective ways to potentially retain more of your wealth to fund your dream lifestyle now and in the future.

Get in touch

We can help you find the most tax-efficient ways to invest your wealth for the future.

Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate tax planning.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.