How to (legitimately) shield your dividends from the taxman

Investors and small business owners have been stung by a tax raid which has robbed them of half of their tax-free allowance for dividends this year. 

The annual dividend allowance – the amount you can earn from shareholder payouts before tax is due – has dropped from £2,000 to £1,000 and will fall again to just £500 next April. 

Around 3.2 million people will be caught when the allowance is halved, HM Revenue and Customs estimated, and a further 1.2 million when the allowance is slashed again next year.

Dividends are taxed at 8.75pc for basic rate taxpayers, 33.75pc for higher rate taxpayers and 39.35pc for additional rate taxpayers. Shareholders will be hundreds of pounds worse off because of shrinking allowances, but there are ways to legitimately shield more money from the taxman.

Tax-free wrappers

The simplest way to reduce your dividend tax bill is to maximise your Individual Savings Accounts (Isa) allowance each year, says Carla Morris, of wealth manager RBC Brewin Dolphin. 

There is no tax charged on dividends received on investments in an Isa, making it one of the most tax-efficient ways to save and invest. You can invest up to £20,000 into an Isa each year. 

Ms Morris said: “This is a ‘use it or lose it’ allowance, meaning you can’t carry it forward to future tax years. Investments held inside an Isa are also free from income tax and capital gains tax.” 

There are four types of Isa: Cash, Stocks & Shares, Lifetime and innovative finance. You cannot open or save into two of the same type of Isa in one tax year, but you can spread the £20,000 allowance across two types of account.

Pay into your pension

Paying into a pension is another tax-efficient way of saving for the future because dividends received by pension funds are tax-free. 

The amount you can save into your pension each year while benefiting from tax relief has increased for 2023-24 to £60,000, up from £40,000. You can also carry forward unused annual allowance from the past three tax years.

Invest as a couple 

If you are married or in a civil partnership and you and your partner are in different tax brackets, then box clever by approaching your investments as a couple. 

Ms Morris said: “If one partner’s income is in a higher tax band, it might make sense to hold income-generating investments in the other partner’s name. 

“Investing as a couple will also ensure you’re making use of each partner’s Isa allowance and dividend allowance.”