The dividend tax allowance had previously sat at £5,000, until it was cut to £2,000 in 2017.
Dividend payments in both the UK and internationally are at record highs.
According to the latest data from Link Group’s Dividend Monitor Report, UK dividends jumped by 10.7% to a record £110.5 billion in 2019.
This was artificially boosted by special dividends, which added a £12 billion to the headline figure. Underlying dividends (excluding specials) rose by 2.8%, reaching £98.5 billion in total payouts.
Meanwhile, internationally, dividends reached a new record of $1.43 trillion in 2019, with an underlying growth rate 5.4%. A strong dollar held back the headline rate to 3.5%.
However, while this increase in dividends is likely to be welcomed by investors, it comes with a sting in the tail: higher payouts for some investors will result in more investors being subject the dividend tax.
As Sarah Coles, personal finance analyst at Hargreaves Lansdown notes: “Such a high level of dividends have been great news for income investors, who have been able to withdraw more income without eating into their investments - or reinvest it to supercharge growth.”
However, she continues: “But there’s a cruel tax twist in this upbeat tale - because higher dividends mean more investors have received dividend payments over £2,000 – and as a result have faced unexpected tax bills.”
The dividend tax allowance had previously sat at £5,000, until it was cut to £2,000 in 2017. At the time the cut was a surprise, as the new dividend tax system was only introduced a year earlier.
Currently, while investors do not need to pay tax on the first £2,000 of dividend income in each tax year, dividends above that threshold are taxed at 7.5% for basic-rate taxpayers, 32.5% for higher-rate taxpayers and 38.1% for additional-rate taxpayers.
With last year’s FTSE 100 dividend windfall, many more investors are likely to unexpectedly see themselves breach the £2,000 allowance. According to figures from Hargreaves Lansdown, in this tax year an estimated £770 million in dividends will fall within the personal allowance
The importance of tax wrappers
One of the best ways to protect against tax is to ensure the Isa allowance is fully utilised. Up to £20,000 per year can be put into an Isa, and any money invested in the wrapper is not subject to either capital gains or dividend tax.
Investors with large holdings outside Isas and pensions should consider carefully moving them into the wrapper, however, to avoid the prospect of a capital gains tax bill.
Those in this position can take advantage of the allowance by moving existing taxable holdings into the wrapper. The process, known as 'bed and Isa' or 'bed and Sipp', involves selling enough of your investment to realise gains up to the value of the capital gains tax exemption (£12,000) for the 2019/20 tax year) and then buying them back within your Isa or Sipp, or that of your spouse.
However, you need to be aware that there may be transaction charges involved and there may be a period when your money isn't invested. Some brokers offer a ‘Bed & Isa’ option when you come to sell; if you tick the box, your holding will be sold and instantaneously rebought within your Isa, minimising the risk of price moves when you’re out of the market.