The Stealth Taxes Draining Your Money

The government has not raised income tax rates. It has not made a headline-grabbing announcement about taxing your savings or investments. But over the past eight years, a series of cuts to the amount you can earn from investments before paying tax has had exactly the same effect on millions of ordinary savers. The money leaving your pocket is real. The changes responsible for it have barely been reported.

Here is what has happened, and what you can do about it.

What is a dividend, and why does the allowance matter?
A dividend is a portion of a company’s profits paid out to people who own shares in that company. Think of it like a thank-you payment for investing in the business. Many investors, and a large number of people who run their own businesses, receive income this way.

In 2016, you could receive £5,000 in dividends each tax year before owing any tax on them. Today that allowance is £500. That is a 90% reduction in eight years. HMRC (the government body that collects tax) estimates that 4.4 million people are now affected by this cut.

If you earn dividends above that £500 threshold, the rate of tax you pay depends on how much you earn overall. Someone who pays the basic rate of income tax (20%) pays 8.75% tax on dividend income above £500. Someone in the higher rate band (40%) pays 33.75%. Someone in the additional rate band (45%) pays 39.35%.

To put that in plain terms: a basic rate taxpayer receiving £2,000 in dividends would now hand over £175 to HMRC that they could have kept entirely in 2016. The income is the same. The outcome is not.

For people who pay themselves partly in dividends, typically those who run small businesses or work as contractors, the cumulative effect over several years can run to thousands of pounds.

What is Capital Gains Tax, and how has the allowance changed?
Capital Gains Tax is a tax on the profit you make when you sell something for more than you originally paid for it. So if you bought shares for £5,000 and later sold them for £8,000, the £3,000 profit is what gets taxed, not the full £8,000. This tax can apply to shares held outside an ISA, a second property, cryptocurrency, or business assets.

Until recently, you could make up to £12,300 in profit each tax year before paying any Capital Gains Tax at all. That allowance has now been cut to £3,000. For many investors, this means that a routine tidy-up of their investments can now trigger a tax bill that would not have existed two years ago.

The Capital Gains Tax rate on shares and investments currently sits at 24% for higher and additional rate taxpayers.
The practical effect is that people who have been building wealth outside of ISAs or pensions, which is a common and entirely sensible approach, now face a much lower threshold before tax applies to the growth they have worked to create.

What is changing with pension inheritance tax?
Right now, when someone dies and leaves their pension to a family member, that pension pot does not usually count towards inheritance tax (a tax on the estate of someone who has died, charged at 40% on anything above £325,000). This has made pensions a useful way for families to pass wealth down the generations.

From April 2027, this is due to change. Pension pots will be brought into the scope of inheritance tax for the first time, meaning they will be counted as part of a person’s estate when they die. For families with larger pension pots, this could result in a significant tax bill.
This will not affect everyone immediately. However, anyone with a pension they are not planning to use fully in their own lifetime should review their position before 2027.

What you can do
The most straightforward way to protect against all three of these changes is to move more of your investments into an ISA. An ISA (Individual Savings Account) is an account where your money can grow completely free of income tax, Capital Gains Tax, and dividend tax. You can put up to £20,000 into ISAs each tax year, and anything held inside is protected from all three of the taxes described above.

A pension is also worth maximising. When you pay money into a pension, the government adds tax relief on top, which is essentially a top-up based on the income tax you pay. Growth inside a pension is also sheltered from tax while it remains invested.

If you currently hold investments in what is known as a general investment account (a standard investment account that sits outside an ISA or pension), you may want to consider a strategy called Bed and ISA. This simply means selling investments held in the general account and rebuying them inside an ISA, gradually moving your portfolio into a tax-free environment. Each sale counts against your current £3,000 Capital Gains Tax allowance, so it is worth spreading this across more than one tax year where possible.

For anyone with a large pension or an estate that is likely to exceed the inheritance tax threshold, speaking to a regulated financial adviser before April 2027 is worth considering.

What to do next
Find out more about ISAs and compare your options: investinginsiders.co.uk/best-stocks-shares-isa

Use our Capital Gains Tax calculator to understand what a sale could cost you: investinginsiders.co.uk/capital-gains-tax-calculator