Advisers have just over a year to organise their clients' dividend income to shield it as much as possible from the reduction in the tax-free dividend allowance but, says Rachel Vahey, they do have a range of options to consider
One of the most significant changes from the 2017 Spring Budget is the reduction in the tax-free dividend allowance from £5,000 to £2,000. It affects shareholder directors and investors with significant portfolios - of typically more than £50,000 - and means more people may have to pay more tax on their dividend income.
The change is effective from April 2018, leaving advisers and their clients just over a year to organise their dividend income to shield it as much as possible from increased tax charges. Clients and their advisers do, however, have a number of options to consider.
1. Using the tax-free dividend allowance
Clients will continue to have a £2,000 tax-free dividend allowance, which means they will be able to hold £50,000 in stocks yielding 4% before having to pay any tax on dividend income.
They may want to consider moving their highest-yielding stocks into Isas or pensions, while keeping the lower-yielding stocks outside the Isa.
2. Using Isas
Clients could use Isas to shield their dividend income as they offer tax-free income and growth. By acting before the end of this tax year, clients can shield up to £55,240 in a stocks and shares Isa by the time the new allowance comes into force:
* £15,240 in 2016/17
* £20,000 in 2017/18
* £20,000 on first day of the tax year, 6 April 2018.
By using both of a couple's allowances, this could mean investing up to £110,480 over three years.
If clients sell existing share holdings and reinvest the proceeds in an Isa using the ‘bed and Isa' rules, this may give rise to a capital gains tax charge, although it could be partially or fully covered by the individual's £11,100 (2016/17) capital gains tax exemption.
Clients need to be aware that Isas, unlike direct share holdings, cannot be placed into trust for inheritance tax (IHT) planning. Instead, when the client dies, the Isa will remain within the estate for the purposes of IHT. This is in sharp contrast with pension investments, which are usually deemed to be outside the estate.
3. Using Sipps
Clients could also use Sipps to shield dividend growth. They can usually invest up to £40,000 a year in pensions - unless they are subject to either the tapered annual allowance (affecting those who earn more than £150,000) or the money purchase annual allowance (MPAA). The MPAA is £10,000 for 2016/17, falling to £4,000 for 2017/18.
Again, the client may choose to sell existing share holdings and reinvest these in a Sipp, or to make an in-specie contribution into the Sipp, although this will mean triggering a disposal for capital gains tax.
Clients will benefit from tax relief on contributions at their current marginal rate. They will, however, be unable to access their investment until age 55, when 25% can be withdrawn tax-free. Tax will have to be paid on the remainder at the client's marginal tax rate although advisers will be able to help their clients manage this tax charge.
4. Switching investment objectives
For any shareholdings that cannot be shielded in Isas or Sipps, clients could consider switching their investment profile - moving from an emphasis on generating income to one centred on capital appreciation. If clients decide to reduce their income-generating investments, they could also choose to regularly sell investments or gains to supplement their reduced dividend income.
While these actions may be helpful in reducing dividend income tax liability, they may store up future capital gains tax charges unless planning is undertaken to counter this.
5. Gifting shares
Finally, the client could gift part of their shareholdings to a spouse or a civil partner to ensure the couple can benefit from two lots of tax-free dividend allowances. If the client and their spouse or civil partner are living together this will not give rise to a capital gains tax liability. Their spouse or civil partner may, however, have to pay tax on any gain if they later sell the shares. The gain or loss will be worked out from when the client first owned the shares.
The tax rules for shareholders have been changing fast. The tax-free dividend allowance was only introduced a year ago, and now it is being more than halved.
These quick-fire changes send out a confused message to those trying to save for their futures, and makes it difficult to set a long-term plan. But it also flags up the need for shareholders to work with their advisers to make sure their investment portfolio is tax-efficient. Tax is not the only consideration when setting the right portfolio, but it is an important one.
Rachel Vahey is product technical manager at Nucleus Financial
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