How much tax do you pay on dividend income?

Dividends face a new tax threat, and even investors with relatively modest share or fund holdings need to take note.

| 7 min read

Dividends are payments made by companies to their shareholders when distributing profits, and they are an important engine fuelling stock market returns.

The reinvestment of dividends can be a powerful force, compounding returns to produce substantial growth over time. Even if a share or the stock market doesn’t appreciate much, or even falls, the effect can mean your money still grows.

As well as being important for investors who are looking to build long-term wealth, dividends can help fund income needs in retirement or for other financial goals. Dividends from successful companies can grow over time, providing a rising, and potentially inflation-beating, stream of income.

Yet dividends face a new tax threat, and even investors with relatively modest share or fund holdings need to take note.

What are dividend tax rates in 2024/25 and how much is tax-free?

Dividends are paid gross, with no tax deducted, and everyone is allowed to earn an amount tax free each year. Having fallen markedly in recent years, the tax-free ‘dividend allowance’ for 2024/25 is £500.

If your dividend income is less than £500 in the tax year, then you don’t need to pay any income tax on the amount, regardless of whether you are a basic, higher or additional rate taxpayer. In addition, any dividends received from investments in an ISA or pension such as a Self-Invested Personal Pension (SIPP) are free from income tax.

Outside of any tax-sheltered investments and the dividend allowance, the dividend tax rates are:

  • 8.75% for basic rate taxpayers
  • 33.75% for higher rate taxpayers
  • 39.35% for additional rate taxpayers

Dividends also count towards your annual income and any amount of dividend income falling within your income tax personal allowance is also tax-free. The personal allowance is currently £12,570 and first applies to non-dividend income – i.e. from earnings or pensions.

Chancellor Jeremy Hunt has frozen the personal allowance, which is set to remain at this level until April 2028. Previously, it has risen roughly in line with inflation.

What counts as dividend income?

UK shares and collective investments such as unit trusts and OEICs may pay dividends to investors. For UK shares it is clear cut – any income paid is classed as a dividend.

Yet for funds the situation is more complicated. If the fund holds 60% or more of its assets in fixed income investments such as bonds, then income paid counts as interest rather than dividend income. It is taxed accordingly at your usual rate of income tax, but the ‘personal savings allowance’ can mean all, or a portion of this, is tax free – there’s more information on this from the HMRC website here.

For funds with less than 60% in fixed income investments, any income will be classed as dividend. Investors should be aware that accumulation units (where income is reinvested automatically for you back into the fund) attract tax income tax on dividend or interest in the same way as income units (where income is paid out).

Don’t assume that your return from a fund is all ‘capital gain’ rather than income because you are not actually receiving it. You do have to pay income tax on reinvested dividends.

How much dividend tax will I pay?

The amount of tax you will pay on dividends will depend on the ‘yield’ produced by your chosen investments that are outside of tax-efficient wrappers such as ISAs. This is the amount they pay out annually as a percentage of their share or unit price.

Different shares and collective investments funds pay out different amounts to investors. Multiplying the value of the investment by its yield will tell you roughly how much income you can expect to receive – and give you an idea of any potential tax liability.

For instance, a basic rate taxpayer has £10,000 in company XYZ and its yield is 4%. They can expect to receive £10,000 x 0.04 = £400 a year in dividend income. If they have also already used their dividend and personal allowances elsewhere, they would have pay tax of £400 x 0.0875 = £35.

Please remember the value of investments, and the income derived from them, can fall as well as rise, which means yield calculations only offer a rough estimation of what you could expect. When you come to report dividend income to HMRC – as described on the HMRC website – you will be required to state your dividend income in terms of the precise value received.

A threat to dividend earners – how the dividend allowance has fallen

Having been reduced from £5,000 to £2,000 in 2017, and subsequently to £1,000 for the 2023/24 tax year, the dividend allowance of £500 in the 2024/25 tax year is a shadow of its former self.

This potentially means lots more people will end up paying tax on their dividends and reporting dividend income to HMRC each year. It also has implications for self-employed individuals that pay themselves income via their own company.

How to pay less tax on dividends

The reduction in the dividend allowance emphasises the need to use tax-efficient ISA accounts, or pensions, to house investments as far as possible. Any income is tax free, as are any profits. Using as much of the annual ISA allowance of £20,000 each year as you can means it is possible to build up a significant portfolio of investments sheltered from tax, plus you can reduce or eliminate the fiddly administration involved in tax returns or HMRC reporting.

If you are married or in a civil partnership, you can also consider splitting income producing assets, either by holding them in joint names or allocating them to the partner with the lower income and tax liability.

You can also consider how you arrange your asset types. For instance, it can make sense to prioritise your ISA allowances for dividend-producing investments rather than cash. For some individuals, the personal savings allowance applied to interest on cash is significantly higher than the dividend allowance, at up to £5,000 for the ‘starter rate’, and the return on cash is often lower than that from dividends. However, the situation will depend on tax position, the mix of assets you own and how much you get paid in interest on cash.

Finally, if you have earned income from employment or self-employment and want to reduce your tax bill more generally, you could consider additional pension contributions. These can have the effect of reducing your earned income so that less of your income falls into higher tax bands. Please note that income tax rates and bands are different in Scotland to the rest of the UK.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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The tax treatment of pensions depends on individual circumstances and may be subject to change in future. It is always recommended that you seek advice from a suitably qualified investment professional if you have any doubt as to the suitability of a pension and/or the underlying investments. You should be aware that Stakeholder Pension Schemes are generally available and might meet your needs as well as a SIPP. Please remember the value of investments may fall as well as rise and your capital is at risk.

Charles Stanley is not a tax adviser. Information contained within this page is based on our understanding of current HMRC legislation. Tax reliefs and allowances are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice.