< Our financial advice

How dividend income is taxed

Getting to grips with annual allowances

Dividends are payments made by companies to their shareholders when distributing any profits they’ve made.

Shareholders in limited companies and some collective investment funds may receive dividends.

Here we explore some of the tax rules around dividends, as well as how you could use your investment allowances to make the most of your money. 

Dividend allowance

How dividend income is taxed

Everyone gets an annual dividend allowance of £2,000 a year.

If your dividend income is less than £2,000 in a single tax year, then you don’t need to pay any Income Tax on the amount.This applies to basic, higher and additional rate tax payers. 

For dividend income over £2,000, Income Tax will be paid at the following rates:

  • 7.5% for basic rate taxpayers
  • 32.5% for higher rate taxpayers
  • 38.1% for additional rate taxpayers

Dividends for investors

Shares, unit-trusts, OEICs and investment trusts produce investment returns in 3 ways:

  • Dividend income
  • Interest income (if the fund holds 60% or more of its assets in fixed income investments)
  • Capital growth

The dividend rules mean that shareholders can hold a reasonable amount of shares in limited companies or investment trusts, or units in unit trusts and OEICs, without breaching the £2,000 dividend allowance.

Different shares and collective investments (unit trusts, OEICs and investment trusts) pay out different dividend amounts to investors. The amount they pay out as a percentage of their share price is called a yield. 

The exact amount of shares you can hold without paying tax on the dividends will depend on the yield produced by your chosen investments.

The lower the yield, the higher the value in shares you can hold without paying tax on dividends, and the higher the yield, the lower the value in shares you can hold without paying tax on dividends.

Tax on capital growth

Capital growth is any increase in the value of shares you hold. It’s taxed under the Capital Gains Tax rules in the tax year in which an investment is 'cashed in' (known as ‘disposal’). 

Each person can use their annual Capital Gains Tax exemption to cover disposals, but the allowance cannot be carried forward – so if you don’t use it, it’s lost forever.

Dividend rules for investments in shares and share-based funds 

Some shares and funds deliberately aim to provide most of their return through dividends rather than capital growth. These are often referred to as ‘income stocks’ or ‘equity income funds’. 

  • Selecting equity income funds allows investors to utilise the £2,000 annual dividend allowance and avoid paying Income Tax on dividend income up to this amount
  • Although the potential for capital growth in these funds is usually lower, capital growth and capital gains can still occur
  • If the capital gain is less than the annual Capital Gains exempt amount, then no tax would be paid on gains either

By using these 2 tax allowances, investors can achieve ISA-like tax treatment of their share-based investments without using up their ISA allowance. This is a complicated process and depends on certain circumstances, so you might want to consider financial advice (for which a fee may be charged).

The value of investments can go down as well as up. You may get back less than has been paid in.

This article is not intended to give advice or a personal recommendation. If you need a personalised recommendation based on your personal circumstances, you should seek financial advice.

Looking for financial advice?

Visit our financial advice page to see what we offer.

Retirement articles

Take a look at our latest news and guides.

Contact us

Still need help? Give us a call.

0800 068 6800

Monday to Friday: 8:00 – 20:00

Saturday: 9:00 – 17:00

Sundays and Bank Holidays: 10:00 – 16:00

For our joint protection, telephone calls may be recorded and/or monitored and will be saved for a minimum of five years. Calls to 0800 numbers from UK landlines and mobiles are free.