Tax on dividend income explained

What is dividend income?

A dividend is a payment made by a company to their shareholders from the profit they make. If you hold shares in a business that declares a dividend, you receive a certain amount for each share you hold. 

For example, if a company declares a dividend of 5p per share and you own 1,000 shares, you’d receive £50. 

Depending on the company, dividends can be paid once or twice a year, or sometimes even more regularly with a quarterly or monthly payment schedule.

Why are dividends important? 

Dividends are a powerful engine that fuels stock market returns and reinvesting them can help to elevate your returns through compounding. Even if a company’s share price or the wider stock market doesn’t appreciate much, or even falls, receiving additional income through dividends can mean your money still grows. 

Dividend payments should be an important part of an investors’ toolkit for those who are looking to build long-term wealth, but they can also help to provide an income in retirement. Dividends from successful companies tend to grow over time – providing a rising and potentially inflation-beating – stream of income.

Yet dividends face a growing tax threat, and even investors with relatively modest investment portfolios need to take note. 

Is dividend income taxable?

Yes, income from dividends is taxed in a similar way to other forms of income such as savings interest or rental income from property. However, the dividend tax rates are lower reflecting the fact that corporation tax has already been paid on the company profits generating them.

Tax on dividend income: what are the tax rates and how much is tax-free?

Dividends are paid gross (with no tax deducted) and everyone has a tax-free dividend allowance. Having fallen markedly in recent years – from £2,000 in the 2023/24 tax year – the allowance for 2024/25 and thereafter is only £500. And there’s no guarantee this allowance won’t be taken away entirely in the future.

If your dividend income is less than £500 for the tax year then you don’t need to pay any income tax on the amount – regardless of whether you’re a basic, higher or additional rate taxpayer. In addition, any dividends received from investments within 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 income tax rates are currently:

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

Dividends also count towards your annual taxable 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. 

The personal allowance is currently set to remain frozen at this level until April 2031. Prior to 2020 it had risen roughly in line with inflation. 

What will change from the 2026/27 tax year? 

In the Autumn Budget, the chancellor announced an increase to tax on dividend income by 2 percentage points for the basic and higher tax rates. This change will take effect from the 2026/27 tax year starting next April. The new tax rates will be:

• 10.75% for basic rate taxpayers
• 35.75% for higher rate taxpayers
• 39.35% for additional rate taxpayers (remains unchanged)

At the same time – like the income tax personal allowance – the dividend allowance of £500 is to be maintained at its current level, providing only limited shelter, and the overall income tax bands are presently frozen.

While businesses may be the main target of the increase in dividend tax rates, owners of shares or funds outside of tax-efficient wrappers are caught too. Wherever possible, investors should consider moving income-paying investments to an ISA or SIPP account. These types of investment accounts act as a shield from the ratcheting up of dividend taxes. Another benefit is that any investments held in these tax-efficient accounts aren’t subject to capital gains tax (CGT) on disposals.

However, moving shares into an ISA involves a sale and repurchase, known as a ‘Bed and ISA’, which locks in any gain (or loss) made on the shares at that point – which could result in a  CGT liability.

What is classed as dividend income?

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

However, for funds, it’s not as simple. If the fund holds 60% or more of its assets in fixed income investments – such as corporate and government bonds – any income paid counts as interest rather than dividend income. Interest 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 dividends. Investors should be aware that accumulation units (where income is reinvested automatically at source) is still subject to tax in the same way as income units (where income is paid out).

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. 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 for the 2025/26 tax year.

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. 

How the dividend allowance has fallen and frozen

The dividend allowance was reduced from £5,000 to £2,000 in 2017, and then to £1,000 for the 2023/24 tax year, the dividend allowance of £500 for the 2024/25, 2025/26 and 2026/27 tax years 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 via dividends from their own limited company.

How to pay less tax on dividends

The reduction in the dividend allowance and upcoming increase in dividend tax rates highlights the need to use tax-efficient ISA accounts, or pensions, to house as many investments 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 self assessment tax returns or HMRC reporting.

If you’re 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 income-paying 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, for example into a Self-Invested Personal Pension (SIPP). These can have the effect of reducing your earned income so that less of your income falls into higher tax bands. 

As well as tax relief on contributions, investment growth and dividend income are tax free in the account. Withdrawals from a pension are, however, taxable, beyond the first 25% usually.