If you are an income investor, the latest Association of Investment Companies Dividend Heroes list should be welcome news. This list of investment trusts that have increased their dividends every year for at least 20 years is now 18-strong, and eight of these trusts, including City of London Investment Trust (CTY), Bankers Investment Trust (BNKR) and Alliance Trust (ATST), have increased their dividends every year for an impressive 50 years or more. But with the first of two cuts to the dividend and capital gains tax (CGT) allowances taking effect in April, investors may need to be more flexible about how and from where they take income.
Firstly, use all your allowances and draw from different accounts. You can take income and gains from individual savings accounts (Isas) tax-free, so hold as many of your investments as you can in these. You can put up to £20,000 a year into this wrapper and if you are married or in a civil partnership also make use of your spouse's allowance so that, together, you have a £40,000 annual allowance. If your spouse doesn't have assets to put into Isas, you can transfer unwrapped assets in your name to them without incurring CGT.
Investments in pensions can also grow and deliver income without incurring tax, however you may be taxed at your marginal income tax rate on anything you take from them in excess of your 25 per cent tax-free lump sum. Taking the tax-free money and making annual withdrawals up to the value of your personal allowance of £12,570 could be an option. But if you already receive the full state pension this uses up most of your annual personal allowance. And if you are looking to leave assets to your children it is probably best to draw from other assets first, as pensions can be passed to beneficiaries without incurring inheritance tax.
You will still be able to receive dividends outside tax-efficient wrappers worth £1,000 and gains of £6,000 in the 2023-24 tax year, and £500 and £3,000, respectively, thereafter. Although a lot less, if you take these amounts in combination with Isa and possibly pension withdrawals and/or your state pension, it adds up. Also, if you are a basic or higher-rate taxpayer, you can receive interest from cash tax-free each year worth up to £1,000 or £500, respectively, and there are some relatively attractive rates on cash at the moment. Again, if you are in a couple you can double up on these amounts.
Outside Isas, tempting as it may be just to invest in reliable dividend payers such as Dividend Hero investment trusts, don't just focus on income investments. Also generate a good total return from growth investments, and sell shares or units in these to contribute to your income, so that you can use both your dividend and CGT allowances. Also do this within Isas and pensions – although tax is not a concern, you shouldn’t just chase the highest yields. Investments can be high-yielding because there is a problem that may impact their future growth and income prospects, or the dividends may not be sustainable. Focusing solely on high dividends also means that you might forego some strong growth investments and the opportunity to sell these shares or units tax-free within your Isa to create an income. A strong tilt to dividends means that your portfolio could become biased to certain sectors and types of companies, concentrating risk. (Also see The investment trusts promising stellar dividend growth pp 32-33)
That said, growth sectors can be volatile and experience large falls so also don't restrict yourself to these.
Don't write off any markets or geographies. Scour the whole investment universe for equity income so that you are less vulnerable to dividend cuts in any one market and less likely to miss out on reliable dividend-paying companies elsewhere.
Also invest in assets other than equities. Rising interest rates have resulted in bond yields becoming more attractive and ways to access these include the Janus Henderson Strategic Bond (GB0007502080), Jupiter Strategic Bond (GB00BN8T5596) and MI TwentyFour Dynamic Bond (GB00B57TXN82) funds. Alternative assets such as infrastructure and renewable energy infrastructure investment trusts have also been reliable sources of income, even if they do not have such long records as the Dividend Hero trusts due to being launched within the past two decades. These include Renewables Infrastructure Group (TRIG) which invests in onshore and offshore wind, and solar power in the UK and Europe.
