UK investors to pay increased tax on dividend income

There will be a 1.25% increase in national insurance and an identical hike in the tax on share dividend income

UK investors to pay increased tax on dividend income

The government has proposed a 1.25% increase in the tax on share dividend income alongside the same rise in national insurance.

This afternoon the Prime Minister unveiled his planned tax on earnings before parliament, having only put the proposal before his Cabinet this morning.

Boris Johnson said on social media ahead of a statement to parliament that the increase to national insurance was to help fill a gap in funding for social care and a “catch-up programme” for the NHS.

NEW: After the dividend tax hike all bets are off about further policy pain for investors in next month's Budget

In a speech to the House of Commons, he said this would be a 1.25% “health and social care levy” applied to income earned by all workers who earn above the limit, including those over state pension entitlement age.

Following criticism about the unfairness of the tax rise, several Westminster reporters tweeted that the hike in the amount of tax paid on income from share dividends is to help cover the costs of the package.

Johnson said the 1.25% increase on the tax on dividends would when combined with the higher NI rate, raise £36bn for the NHS and social care.

He said hiking both NI and dividend taxation “will share the cost between business and individuals”, calculating that the highest-earning 14% of individuals will pay around half the revenue from the levy.

It was calculated that investors and the self-employed will collectively pay £600mln more in tax as a result of the dividend tax increase, with retail investors only impacted if they have significant portfolios outside of a pension or ISA, which shelter dividends from tax.

The government's move follows the 60% slashing of the tax-free dividend allowance from £5,000 to £2,000 in 2018.

Higher tax bills all round?

Laura Suter, head of personal finance and AJ Bell, said the dividend tax hike will be felt the most by company directors, including the self-employed and contractors, who pay themselves via company dividends in addition to salary.

“The move means that anyone taking home more than £2,000 a year in dividends will now face a slightly higher bill. At £10,000 of dividends this equates to £100 a year more, regardless of your tax bracket, while at £20,000 a year it means an extra cost of £225.

Individual investors will only face a higher tax bill if their annual dividends are over the annual dividend allowance of £2,000, Suter added. 

“To be in that position you’d have to have a portfolio of over £50,000 if it was yielding 4% a year and the government estimates that around 60 per cent of people who have dividend income outside of ISAs will not see a tax increase next year.”

For business owners, paying themselves in dividends will often still be more tax efficient than paying themselves more income, said Sarah Coles, personal finance analyst at Hargreaves Lansdown.

This, she says, is because even after the change, dividend tax will still be lower than the equivalent income tax.

As an example, she said a basic rate taxpayer would pay 8.75% on dividends over their £2,000 dividend allowance.

“However, for all those who have struggled through the pandemic, being rewarded for their efforts with a higher tax bill is going to feel like a kick in the teeth.”

Tom Selby, head of retirement policy at AJ Bell, said the government “appears to have been spooked by the backlash over plans to increase National Insurance Contributions to fund its radical social care reforms, [which] would have loaded the costs on younger workers, sparking accusations of intergenerational unfairness”, with proposals for workers of all ages now being asked to pay the increased amount.

“Of course, the bulk of the working population are still under state pension age, meaning in reality this is a National Insurance hike in all but name and it is almost certainly still younger people who will pay the lion’s share of these costs.

“This is likely to prove unpopular with voters, with less than one in six (15%) of people questioned yesterday saying they’d support an increase in National Insurance to fund social care reform. What’s more, it’s a clear breach of the Conservative’s manifesto ‘triple tax lock’.”

Selby noted that the Prime Minister's proposal to use the proceeds of the tax hike to introduce a lifetime cap on social care costs at £86,000 is likely to be partly designed to “and encourage more insurers to enter the market”, while if the levy operates in a similar way to NI, then workers' pensions salary sacrifice “should become more attractive as a result of this announcement” as they will be incentivised to boost salary sacrifice contributions in order to reduce their overall tax bill, while also boosting their retirement pot and benefitting from tax-free investment growth in the process.

“The increase in dividend tax means people investing outside tax sheltered wrappers like pensions and ISAs should review their portfolios to make sure they are making as much used as possible of their annual contribution allowances to keep their tax bills as low as possible,” he said.

Among other effects, economist Sam Tombs at Pantheon Macroeconomics suggested it is also likely to push back the timing of a Bank of England rate hike.

** Update: broker comment added **

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