Income tax on savings and investments
By Ian Robinson
Article 4 of 4
Get to grips with how much tax you'll pay on earnings from dividends and capital gains on shares.
If you invest in shares in a company, there are two ways you can earn money. They can grow in value, allowing you to make a gain when you sell them. Companies also distribute the profits they make in the form of a dividend.
Dividends received in 2016-17
From 6 April 2016, the first £5,000 you receive in dividends from investments is tax free. Above this, basic-rate taxpayers will pay 7.5% tax on dividends, higher-rate taxpayers 32.5%, and additional-rate taxpayers 38.1%.
Non-savings income is normally allocated against your tax bands before savings, dividends and capital gains, so to find out at what rate interest on your savings is taxed, you must add this to your other taxable income.
Higher-rate and additional-rate taxpayers must declare any dividend income on their tax return. If you don't normally complete a tax return and are a higher-rate taxpayer who receives dividends, you need to let your tax office know.
Dividends received in 2015-16
Before April 2016, dividends were deemed to be taxed (at source) at the rate of 10%. This was regardless of whether you chose to reinvest them or had dividends paid in cash. The 10% deduction resulted in a tax credit.
- Basic-rate taxpayers have no further tax to pay.
- Non-taxpayers also have this tax deducted and can't claim it back.
- Higher-rate taxpayers pay dividend tax at 32.5% – but after the tax credit is deducted, this becomes an effective rate of 25% of the dividend received.
- Additional-rate taxpayers pay dividend tax at 37.5% – but after the tax credit is deducted, this becomes a effective rate of 30.6% of the dividend received.
The 'effective rate' applies because, for example, for every £90 in dividends a higher-rate taxpayer gets, they are given a £10 tax credit, which makes a ‘gross’ dividend of £100. Applying the rate of 32.5% to £100 gives £32.50 tax due, but this is reduced by £10 - the amount of the tax credit, to give a remaining liability of £22.50. As a percentage of the £90 received, £22.50 is 25%, so this is the effective rate of tax the shareholder actually pays.
Find out more: the Which? investment portfolios – use our tool to build the perfect portfolio
Capital gains tax on shares
When you come to sell your shares, you could pay tax on any profits you make. This would be capital gains tax (CGT).
There is an annual tax-free allowance in 2016-17 of £11,100 (also £11,100 for 2015-16) for capital gains. If the profit you make when selling your shares is below this threshold, you won't have to pay any tax.
If it is above this level, the profits above £11,100 in 2016-17 (or 2015-16) are taxed as follows:
- At 18% if you're a basic-rate taxpayer and the profits you make do not push your income into a higher tax bracket.
- At 28% if you're a higher-rate or additional-rate taxpayer. You'll also pay this on the proportion that your gain has pushed you into a higher tax bracket if you're a basic-rate taxpayer.
If you own several different holdings of the same shares, HMRC counts the first block as the ones you have sold, calculating your capital gain on this basis.
Find out more: capital gains tax explained - find out more details on CGT and when you need to pay it.
Tax on other investments
Tax on investment funds
If you have holdings in mutual funds, such as unit trusts and open-ended investment companies (Oeics), you pay tax differently depending on the type of assets within the fund.
Equity funds: Funds that invest in shares will distribute the profits made in the form of a dividend. These are taxed in the same ways as dividends paid directly from owning shares (see above).
Bond funds: Funds that invest in corporate bonds or government bonds – the profits made in the fund are paid to you as interest. This is taxable at the following rates:
- 20% if you're a basic-rate taxpayer
- 40% if you're a higher-rate taxpayer
- 45% if you're an additional-rate taxpayer.
Interest received from bonds counts towards the personal savings allowance, so may be tax free, depending on how much savings interest you receive from other sources.
Until 2017, bond funds will continue to deduct 20% at source, so basic-rate taxpayers who owe tax on their interest don't need to pay any more. Higher-rate and additional-rate taxpayers will need to declare interest payments from bond funds on their tax return. From April 2017, tax will no longer be deducted at source.
When you sell your holding in a mutual fund, you will pay capital gains tax on any gain that you make.
Find out more: how to invest - we explain the basics
- Last updated: April 2016
- Updated by: Ian Robinson