How To Cope With The Tax-Free Dividend Allowance Cut

How To Cope With The Tax-Free Dividend Allowance Cut
Underwater by Andy Deitsch. Why?

Now the new tax year is well underway, time is running out until the tax-free dividend allowance is slashed, so here are five things you can do to reduce the negative impact on your money

In A Shock Move, The Tax-Free Dividend Allowance Is Being Cut By More Than Half

STOP PRESS: In another apparent U-Turn, it's been confirmed this proposal has been taken out of the Finance Bill along with 71 other proposals, which the Government has stripped back in order to get it through ahead of the snap general election on 8 June 2017.  However, as this could yet reappear after the election, it's worth checking out the points below about the tax-free dividend allowance.

Five Things To Do To Offset The Cut In Tax-Free Dividend Allowance

Although Philip Hammond didn’t get away with increasing the cost of National Insurance Contributions for the self-employed in his Budget in the spring of 2017, it seems he’s managed to hold onto his proposed reduction in the tax-free dividend allowance.

At the start of the 2018/19 tax year, the tax-free dividend allowance is being cut by more than 50 per cent, from £5,000 to £2,000. 

This dramatic fall could affect you if you’re a shareholding director of a company, or if you have a significant portfolio of stockmarket assets, typically more than £50,000.

The net result is that you may end up paying more tax on your dividend income.

The change is effective from April 2018, leaving you less than a year to consider a variety of options to counter the effect of this swingeing decrease. 

5 Ways To Compensate For The Fall In The Tax-Free Dividend Allowance

Here are five ways to reorganise your money with the aim of shielding it where possible from an increased tax bill.

Maximise Your Tax-Free Dividend Allowance

At least the tax-free dividend allowance isn’t being scrapped!  You’ll have an allowance of £2,000 to play with.  It means you could hold £50,000 in stockmarket assets that yield an average of 4 per cent before you’ll be clobbered for tax on your dividend income.

In reviewing your investments, you may wish to consider moving your highest earning assets into an ISA, SIPP or SSAS, retaining the lowest earning assets outside these tax wrappers and therefore potentially subject to tax.

Make The Most Of Your Tax-Free ISA Allowance

Thanks to a previous Budget change, the ISA allowance has just been increased to £20,000 (2017/18).  It will continue at this level from the start of the next tax year (2018/19).  It means by 6 April 2018, you could salt away £40,000 of your taxable dividend-producing stockmarket assets in a stocks and shares ISA.  You spouse or civil partner could do the same, enabling you to shelter a huge chunk of your capital from the taxman.

If you dispose of your existing stockmarket holdings and reinvest the proceeds in an ISA in a process referred to as ‘Bed and ISA’, this could give rise to a Capital Gains Tax charge.  However, if you haven’t fully utilised your tax-free Capital Gains Tax exemption, which is currently £11,300 (2017/18), you may end up paying no tax at all.

The downside of sheltering your direct share holdings in an ISA is that they cannot be placed into Trust for Inheritance Tax planning.  On your death, your ISA remains inside your estate for Inheritance Tax purposes.  However, pension investments aren’t subject to Inheritance Tax.

Top Up Your SIPP Or SSAS

You could reinvest the proceeds of your stockmarket assets sale as a contribution to your SIPP or SSAS pension tax wrapper.

Contributions of up to £40,000 a year can usually be paid into your pension, subject to your income.  However, if you earn over £150,000 or if you’ve flexibly accessed your pension, you’ll face big reductions in the amount you can save, as a result of earlier heavy slashing of much higher tax-free allowances.

Interestingly, if you have no income at all, you can still contribute up to £3,600 a year and receive Income Tax relief at the basic rate, worth £720.

It may be possible to make an in-specie contribution without selling your stockmarket assets, although it’ll still trigger a disposal for Capital Gains Tax.

The upside of making a pension contribution is Income Tax relief at your marginal rate.  However, you won’t be able to access your money until you’re 55.  The first 25 per cent of it will be tax-free, with any further withdrawals being added to your other income, to be taxed at your marginal rate at the time.

Equalisation Of Your Tax-Free Assets

If you have a spouse or civil partner who’s not making the most of their allowances, or who pays Income Tax at a lower rate than you, you could consider gifting assets to them.  That way, you’ll make the most of two lots of tax-free dividend allowances.

If you’re living together, this won’t give rise to a Capital Gains Tax liability.  But your spouse or civil partner may have to pay tax on any gain if they sell the shares at a later date.

Rethink Your Aims

If you’re unable to shelter your dividend yielding investments in ISAs, SIPPs or SSAS, how about a complete review of your investment strategy?  Instead of income generating assets, you could focus on those that target capital growth.  These assets could be sold as time goes by to top up your reduced income, enabling you to maximise your Capital Gains Tax exemption.

Whilst interest rates remain stubbornly low, deposit based savings might not work at this time, but be mindful of the Personal Savings Allowance as a way of generating a tax-free income in this area.

Start Your Tax-Free Strategy Planning Now

Generally speaking, it’s not a good idea to make your investments first and foremost because of their ability to save tax.  They should always reflect your aims and aspirations and be in line with your attitude to risk and capacity for loss.  But if you can reduce your tax bill in the process, it can swing your thinking one way or another.

It goes without saying that fast moving changes such as the introduction of the tax-free dividend allowance and then a subsequent massive reduction within a very short space of time does make it difficult to plan your investment strategy over a longer period.  So if you’re confused by the changes, you should discuss this in more detail with your trusted professional advisers.

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