If you own shares in a company, then you may receive dividend payments, with many people in their 50s and 60s reliant on them to boost their retirement income.
It’s important to understand how these payments are taxed, particularly considering the upcoming changes to the amount you can take tax-free each year, known as your dividend allowance.
Read on to understand how dividends work, how they are taxed and what changes to the dividend allowance will mean for you.
What are dividends?
Dividends are a type of payment used to transfer a company’s profits to the shareholders as income.
A company’s director or board of directors usually decides when and how dividends are paid. All shareholders in a company are entitled to dividends when they are paid out, with the amount they receive being proportional to the number of shares they have. The amount paid out per share is known as the “dividend rate”.
As dividends are a form of income, they are subject to tax (unless the shares are held in a tax-efficient individual savings account (ISA)), but the taxation rules work slightly differently than with wages. You can find out more about ISAs in our guide Everything you need to know about ISAs.
What is the dividend allowance?
Introduced in 2017, the dividend allowance is the amount that you can take as a dividends tax-free each year. You only have to pay tax on the portion of your dividend payment that exceeds this amount.
The current dividend allowance in the 2022/23 tax year is £2,000. However, in his 2022 Autumn Budget, the Chancellor Jeremy Hunt announced that the allowance would be halved to £1,000 in the 2023/24 tax year and again to £500 in the 2024/25 tax year. This effectively means that shareholders will have more tax to pay on their annual dividend income.
To find out more about the announcements in the Chancellor’s Autumn Budget and what effect they could have on your finances, check out our guide What the 2022 Autumn Statement means for you.
If you are a landlord who lets property out to tenants, and does so using a limited company structure, then the changes to the dividend allowance will likely affect the amount of tax you pay. Find out more in our article Should I own my Buy to Let property through a limited company?
If your only source of income is from dividends, then you should be sure to factor in your personal allowance as well when working out the amount of tax you pay. This is the amount of income (of any kind, including both wages and dividend income) you can earn tax-free each year. Again, this means that tax is only payable on the portion that exceeds this amount. The Personal Allowance in the current 2022/23 tax year is £12,570.
How much tax do I pay on dividend income?
The amount of tax you pay on your dividend income (after taking your allowances into account) will depend on your income tax band. These bands are:
- Basic rate – £12,571 to £50,270
- Higher rate – £50,271 to £150,000
- Additional rate – over £150,000
However, the tax rates themselves on dividend income are different to those for regular income.
The basic rate of dividend tax is 8.75%, the higher rate is 33.75%, and the additional rate is 39.35%.
So, for example, let’s say you receive £5,000 in dividends and £30,570 in wages in the 2022/23 tax year. That’s a total income of £35,570.
In order to work out how much tax you owe, first subtract your personal allowance. £35,570 – £12,570 = £23,000. This puts you in the basic rate tax band.
Next, you can take off your dividend allowance of £2,000, leaving you with £21,000 of taxable income. Of this amount, £20,000 comes from your wages after the personal allowance is applied, so that is taxed at the normal income tax rate. The remaining £1,000 is your dividend income after the dividend allowance is applied, so that’s taxed at the dividend tax rate. So you pay tax as follows:
- 20% income tax on £20,000 (£4,000)
- 8.75% dividend tax on £1,000 (£80.75)
How do I pay dividend tax?
The correct way of paying dividend tax depends on how much you receive in dividends.
To pay tax on up to £10,000 in dividends, you should let HMRC know and they will change your tax code, so the tax will be deducted from your income automatically. Or, if you already fill in a Self Assessment tax return, you can include the dividend tax here.
To pay tax on over £10,000 in dividends, you will need to include it in your Self Assessment tax return.
Do I pay dividend tax on shares from an ISA?
Any dividends from investments held in an individual savings account, or ISA, are free from income tax and do not affect your dividend allowance. You can therefore transfer your shares into an ISA in order to reduce the amount of tax you need to pay. In addition, you do not have to pay Capital Gains Tax (CGT) on any profit you make when you sell such investments when they are held in an ISA.
However, bear in mind you can only pay a certain amount into ISAs each tax year. The ISA limit for the current 2022/23 tax year stands at £20,000. If you don’t use your allowance by the end of the tax year on April 5, 2023, you cannot carry it forward to the following tax year, so it’s a case of ‘use it or lose it’. You can find out more about ISAs in our guide Everything you need to know about ISAs.