Income tax thresholds remaining frozen is causing more taxpayers to fall into higher-rate tax bands. However, it’s important to note that income for tax purposes isn’t just limited to your salary; earnings from savings and investments are also considered by HMRC.
Understanding how dividends and interest are taxed is crucial if you want to organize your assets in a tax-efficient manner.
Interest Tax:
Interest earned from savings above your allowances is taxed at your regular income tax rate. This includes interest from bank accounts, investment trusts (if they pay interest), life annuities, and government or company bonds.
There are three allowances that can shield your interest from income tax, but most individuals can only utilize the third one. The first is the £12,570 personal allowance, typically used up by salary or pension income. The starting rate for savings might apply if your income is below £17,570, allowing you to earn up to £5,000 of interest tax-free. However, this allowance decreases by £1 for every £1 of other income above your personal allowance.
Additionally, there is the personal savings allowance, which is £1,000 for basic-rate taxpayers and £500 for higher-rate taxpayers. Unfortunately, additional-rate taxpayers do not receive this allowance. Whether you need to report to HMRC about exceeding your allowances depends on your employment status and if you have to complete a self-assessment tax return.
Dividend Tax:
Dividend tax rates are determined by your income tax band, with dividends taxed at a lower rate due to already being subject to corporation tax. For basic-rate taxpayers, the dividend tax rate is 8.75%, while higher-rate and additional-rate taxpayers face rates of 33.75% and 39.35%, respectively.
There are two allowances for dividend income: your personal allowance (if not used up by salary or pension) and an additional £500 dividend allowance. If you receive dividends on top of salary or pension income, the dividend income is considered the higher slice of your income when determining the tax band.
To reduce your dividend tax bill, consider transferring dividend-paying assets to a spouse or civil partner in a lower tax bracket. You can also reduce or defer other income to keep dividend income within your personal allowance and dividend allowance for the tax year. Maximizing tax-efficient investment vehicles like ISAs, enterprise investment schemes, or seed enterprise investment schemes can also help minimize tax liabilities.
In conclusion, being aware of how interest and dividends are taxed can help you optimize your tax position and make the most of available allowances and tax-efficient investment options.