Investors getting caught in £90,000 dividend tax trap

In April last year, the dividend allowance shrunk from £5,000 to £2,000 and, before the cut, investors could hold around £135,000 of UK shares outside an ISA before paying tax on dividends, but now that amount is just over £46,500.

If you receive dividends over your allowance outside of an ISA, basic rate taxpayers are taxed at 7.5 per cent on the excess, higher rate taxpayers at 32.5 per cent and additional rate taxpayers at 38.1 per cent.

However, Hargreaves Lansdown has warned investors to “take action now”, even if they are not affected by the change at the moment, as rising dividend yields could leave them facing dividend tax in the future, with higher rate and additional rate taxpayers facing an even higher tax bill.

The firm highlighted that investors can use the Bed & ISA process to protect £20,000 of their existing investments from tax in ISAs this year, ensuring that their investments are free of dividend tax, and capital gains tax too.

Bed & ISA essentially allows investors to sell shares and funds that are outside an ISA and buy them back within the ISA straight away.

Investors can also use the Bed & ISA process to protect another £20,000 of their existing investments from tax in an ISA at the beginning of the next tax year – before any dividends are paid.

Hargreaves Lansdown personal finance analyst Sarah Coles commented: “The stock market has seen an income bonanza. In 2018, the total paid out in dividends hit a record high. In more recent months, dividends have remained fairly resilient, and as share prices backed off from the highs of last spring, the dividend yield has risen to around 4.3%.

“Record dividends are great news for investors, who can boost their investments significantly by reinvesting them, or withdraw more income without eroding their money. Sadly there’s a tax-shaped fly in the ointment, because higher dividends can mean shock tax bills.”

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