Yes. If you’re facing a potential Dividend Tax bill, you do have options. But to make the most of these approaches, you’ll need to plan ahead.
Trying to mitigate a Dividend Tax bill once it’s already been calculated by HMRC is much tougher than creating a long-term plan well in advance.
1. Make full use of your ISA
For many investors, this is the simplest solution.
Once investments are inside an ISA:
Dividends are free from Dividend Tax.
Capital gains are free from Capital Gains Tax.
You don’t need to report ISA dividends to HMRC.
If you still have unused ISA allowance for the current tax year, moving investments into an ISA could reduce your future tax bill.
Moving investments outside an ISA into an ISA is known as a ‘Bed and ISA’.
Because the government doesn’t allow direct transfers on this pathway, this involves:
Selling your investments
Moving the cash into your ISA
Buying the investments back inside your ISA
This can open up a new can of worms as investments that are sold for a profit outside of an ISA are subject to Capital Gains Tax (CGT). But if planned carefully, it’s sometimes possible to do this without paying CGT.
Check out our guide how to perform a Bed and ISA for more.
2. Use your spouse’s or civil partner’s ISA
Each adult has their own ISA allowance.
If your spouse or civil partner hasn’t used theirs, investing across both ISAs may allow more of your investments to grow free from Dividend Tax.
3. Use a pension
Pensions, including Self-Invested Personal Pensions (SIPPs), are another tax-efficient way to invest.
Just like an ISA, any dividends you receive inside a pension are free from
Dividend Tax, regardless of how much you receive. They also don’t use up any of your £500 Dividend Allowance.
The main drawback is that pensions are less flexible than ISAs. In most cases, you can’t access your money until you reach your normal minimum pension age, which is currently 55 and is due to rise to 57 from 2028.
If you already own investments outside a pension, you may also be able to move them into one using a process known as – wait for it – a ‘Bed and SIPP’. This involves selling your investments, paying the cash into your pension and then buying the investments back inside the pension.
But, because the investments have to be sold first, you may have to pay
Capital Gains Tax (CGT) if you’ve made a large enough profit and your taxable gains exceed the annual CGT allowance. Check out our guide on Capital Gains Tax for tips and support on this.
4. Consider growth investments instead
Not every investment pays dividends, so another option is to own fewer investments that pay dividends and instead invest more in ‘growth investments’.
Growth investments don’t usually pay regular dividends. Instead, the companies reinvest their profits back into the business with the aim of increasing its value over time. That means you’re less likely to pay
Dividend Tax while you continue to hold them.
However, that doesn’t necessarily mean you’ll pay less tax overall.
If you later sell a growth investment for more than you paid for it outside an ISA, you may have to pay Capital Gains Tax (CGT) instead. The annual tax-free CGT allowance has also been cut significantly and is now just £3,000. Gains above this amount may be taxable.
One advantage of growth investments is that you usually have more control over when you pay tax. That’s because Capital Gains Tax is normally only triggered when you sell an investment. By contrast, dividends are paid whenever a company or fund decides to distribute them, so you have much less control over when Dividend Tax might arise.
That said, it’s not wise to disrupt your overall investment strategy purely to save tax. Choosing investments just because they don’t pay dividends could leave you with a portfolio that’s less balanced and potentially more volatile.
So keep in mind that, for most investors, growth investments will only form part of a well-diversified portfolio.
5. Consider VCTs
Another option is to invest in Venture Capital Trusts (VCTs). These are specialist investments that support small, young companies with high growth potential.
One of their biggest tax benefits is that any dividends you receive are completely free from Dividend Tax, no matter how much you receive.
However, VCTs are not suitable for most beginners. Because they invest in small, early-stage businesses, they carry a much higher level of risk than most funds and shares. They can also be harder to sell quickly if you need your money back.
For that reason, VCTs are generally only considered by experienced investors who have already used up their ISA allowance and, in many cases, made full use of the tax benefits available through their pension.
As an added incentive, qualifying VCTs also offer 30% Income Tax relief on new investments. For example, if you invest £10,000, you could reduce your Income Tax bill by £3,000.
However, you normally need to keep your investment for at least five years or you may have to repay the tax relief.
6. Keep track of your dividend income
Many people don’t realise they’ve gone over the £500 allowance until the end of the tax year. Keeping a record of the dividends you receive can help you avoid unexpected tax bills.
7. Beware ‘accumulation units’
Keeping a record of the dividends you’ve received can be tricky in some cases.
Many funds offer ‘accumulation units’, which automatically reinvest dividends paid by companies in the portfolio without paying them out of the fund. But don’t get lured into thinking that just because you’ve bought accumulation units, you’ve avoided Dividend Tax. Even though, in these cases, you’ll never see the dividends in your account, they are still taxable.
To help you manage this, your investment platform should provide you with an end of year tax certificate detailing all the dividends received by your investments, including accumulation units. This isn’t ideal as it means you might not have all the figures you need to work out your likely Dividend Tax bill until the end of the tax year, making long-term planning tricky.
However, if you think you may be close to the £500 Dividend Allowance, you can attempt to estimate your dividend income by looking at the fund’s historic distributions or checking whether your platform or fund manager publishes expected distribution amounts.
For most investors, this isn’t something to worry about. If your investments are held inside an ISA or pension, or your dividends are comfortably below £500, you don’t need to track accumulation distributions for Dividend Tax purposes.
