Income tax on savings and investments
By Ian Robinson
Article 4 of 4
Find out how much tax you'll pay on dividend income from shares and how the 2018 dividend tax changes work.
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 profit when you sell them. Companies also distribute some of the profits they make to shareholders annually in the form of a dividend.
Dividends can be a really useful way of generating a regular income from your investments. But, as with any income you earn, you may have to pay tax.
The tax rates on dividends are different to the income tax rates you pay on savings interest, your salary or your pension. And you also get a tax-free dividend income allowance, which allows you to earn thousands of pounds in dividend before you pay tax.
If you hold shares in a stocks and shares Isas - you don't need to pay dividend tax on shares held in an Isa. But this guide explains how dividend income tax works.
- Use the Which? tax calculator to work out your bill and submit your tax return direct to HMRC.
How are dividends taxed in 2016 and 2017?
You can earn £5,000 in dividends before you pay any tax. This is called the 'tax-free dividend allowance'
This applies to the 2016-17 tax year (which runs between 6 April 2016 and 5 April 2017), and the 2017-18 tax year (which runs between 6 April 2017 and 5 April 2018)
Above this dividend income tax-free allowance, you pay tax based on the rate you pay on your other income - known as your 'tax band' or sometimes called your 'marginal tax rate'.
The table below shows the different dividend tax rates for basic, higher and and additional-rate taxpayers.
|Dividend tax rates|
|Income tax band||Rate|
Dividend income tax changes in April 2018
As announced in the 2017 Spring Budget, the dividend tax-free allowance is being reduced.
From 6 April 2018, the first £2,000 you receive in dividends from investments will be tax free, down from £5,000.
This means more people will end up paying tax on the dividends they earn.
How much more dividend tax will I pay in 2018?
The reduction in the tax-free dividend allowance could have a significant impact on your tax bill. For example, if £10,000 of dividends were earned in a year:
- A basic-rate taxpayer would see their dividend tax bill increase by £225
- A higher-rate taxpayer would see their dividend tax bill increase by £975
- An additional-rate taxpayer would see their dividend tax bill increase by £1,143
The chart below shows how much you may need to pay, depending on your total income from dividends and tax band, in 2016, 2017 and 2018.
What rate of dividend tax do I pay?
If you are a basic-rate taxpayer, you may end up paying a higher rate of tax on your dividends.
This is because 'non-savings income' - meaning your salary or your pension - is normally allocated against your tax bands before savings, dividends and capital gains.
To find out at what rate of dividend tax you pay, you'll need to add your dividend income to your other taxable income. If your dividend income pushes you above the higher or additional rate thresholds, you have to pay more tax.
Here's an example.
- In the 2017-18 tax year, the amount you can earn before you pay higher rate (40%) tax is £45,000
- Your annual income from your job is £40,000
- You earn £15,000 in dividend income in that year, taking your total income to £55,000
You would end up paying:
- 0% tax on the first £5,000 of dividends, thanks to the tax-free allowance
- 7.5% on the next £5,000 of dividends, using up the remaining £5,000 on the basic-rate tax threshold
- 32.5% on the last £5,000 of dividends, as this is above the higher-rate tax threshold.
How do I pay dividend income tax?
If you earn up to £5,000 in dividends, you don't need to do anything. No need to inform HMRC, just enjoy your dividend income as you see fit!
But, if you earn between £5,000 and £10,000, you'll need to tell HMRC. You can pay the tax due in one of two ways:
- Have HMRC adjust your tax code, so that the tax is taken from your salary or pension
- By filling out a self-assessment tax return
If you earn more than £10,000 in dividends, you'll need to complete a tax return.
What about tax on dividends earned before April 2016?
Before April 2016, dividends were taxed differently. Any dividends you earned were deemed to have been taxed at 10% before they were paid to you.
This was regardless of whether you chose to reinvest them or had dividends paid in cash. The 10% deduction resulted investors being given a tax credit. This meant that:
- Basic-rate taxpayers had no further tax to pay.
- Non-taxpayers also had this tax deducted and couldn't claim it back.
- Higher-rate taxpayers paid dividend tax at 32.5% – but after the tax credit, this became an effective tax rate of 25%.
- Additional-rate taxpayers paid dividend tax at 37.5% – but after the tax credit, this became an effective tax rate of 30.6%.
But how did this 'effective tax rate' work?
For every £90 in dividends a higher-rate taxpayer received, they were given a £10 tax credit, which makes a 'gross' dividend of £100.
Applying the rate of 32.5% to £100 gave £32.50 tax due. But this was 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 was the effective rate of tax the shareholder actually pays.
Do I pay dividend tax on equity 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 taxed at the following rates:
|Income tax rates|
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 deduct 20% tax 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 need to declare interest payments from bond funds on their tax return. From April 2017, tax is no longer be deducted at source.
When you sell your holding in a mutual fund, capital gains tax may be payable on your profits (see below).
Find out more: how to invest - the basics
Do I pay 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).
Much like dividends, you get an annual tax-free allowance on capital gains.
- In 2016-17, the capital gains tax allowance is £11,100
- In 2017-18, the capital gains tax allowance is £11,300
If the profit you make when selling your shares is below this amount, you won't have to pay any tax.
Above this level, profits are taxed at 10% if you're a basic-rate taxpayer, or 20% if you're a higher or additional-rate taxpayer.
Find out more: capital gains tax explained - understand CGT and when to pay it.
- Last updated: March 2017
- Updated by: Tom Wilson