While a rise in tax is never welcome, it's important not to overreact and unnecessarily change your investment strategy or you could fail to meet your objectives or – even worse – lose money that you need. A way to mitigate dividend tax, which rises in April next year, is to hold growth rather than dividend-paying investments, and sell chunks of them to create an income – as set out in this week’s funds article. But this approach to getting an income involves a number of risks, so only pursue it if you really need to and it is suitable for your personal investment profile and circumstances. And if you do, don’t allocate your entire portfolio in this way.
The best way to mitigate the dividend tax rise is to hold as many of your dividend-paying investments as possible within an individual savings account (Isa). If you don’t have room for all your investments in your Isa, prioritise holding income investments over growth investments within it. At present, you can invest up to £20,000 each year into an individual savings account (Isa), or for a couple £40,000.
You can also take up to 25 per cent of the value of your pensions tax-free. Withdrawals above this are taxed at your marginal income tax rate, but the personal allowance enables you to earn income of up to £12,570 in the current tax year before you pay any tax on it.
And you can receive £2,000-worth of dividends from investments outside tax wrappers such as pensions and Isas tax-free each year – so £4,000 for a couple.
“If you assume a 4 per cent yield on shares or equity funds, you need to be holding over £50,000 of non-tax-wrapped equities to exceed the £2,000 dividend allowance,” explains Jason Hollands, managing director at investment platform Bestinvest.
Also, if any of your dividends from unwrapped investments exceed the dividend allowance, the extra tax each year is not likely to be a huge amount. For example, a higher-rate taxpayer who receives £20,000 a year in unwrapped dividends currently pays £5,850 dividend tax (32.5 per cent of £18,000) and at the new 33.75 per cent rate will pay £6,075.
So while the dividend tax rise might be unwelcome it probably won’t require you to rethink your whole investment approach.