When receiving a dividend, it’s considered a form of income. Even though you may have already paid some form of tax on the money you invest in a company, you will still have to pay tax when earning dividends. If you hold shares outside of a stocks and shares ISA, you will need to pay tax and this guide will run you through everything for the UK.
What is a dividend?
When a company makes a profit it can choose to pay out a portion of this to shareholders in the form of a dividend. The amount is usually small but can become substantial once reinvested and allowed to compound. This is called dividend investing and is what I adhere to for FIRE.
Dividends are usually paid out in cash and are declared per share. If Apple pays out a dividend of $0.10 per share and you own 100, that payment would result in you receiving $10. Since this is a source of income, the UK Government and HMRC would like to take a portion of your earnings.
Dividend tax allowance
For the tax year 2021/2022, the dividend amount you are allowed to keep to yourself without paying tax is £2,000. You will only need to pay tax on dividends that are earned thereafter. For instance, if you earned £2,500 in the current tax year, you will be required to pay tax on that additional £500 that’s outside the allowance.
Once you make more than £2,000 in dividends per year, you will be taxed depending on your income tax bracket.
- Basic-rate taxpayers: 7.5%
- Higher-rate taxpayers: 32.5%
- Additional-rate taxpayers: 38.1%
How to pay tax
If you already file a Self Assessment return with HMRC, you will need to add the dividends earned as additional income, but if you do not file a return (perhaps you’re full-time employed) you may be required to do so. HMRC actually has a tool on its website that will allow you to check if you need to send a Self Assessment tax return.
You can also speak to a certified accountant/advisor or even contact HMRC directly for assistance. If you earn less than £10,000 from dividends, HMRC will be okay with adding the amount owed to your PAYE code and collect it through your wages. If you pass the £10,000 threshold, you will need to file a Self Assessment tax return.
Pay zero tax with an ISA
The stocks and shares individual savings account (or ISA for short) truly is magical. By investing in an ISA instead of a general investing account, you will be able to reinvest dividends for free. The UK Government will take nothing from you, even if you decide to sell everything and withdraw at a later date.
This is why I recommend using stocks and shares ISA only until you max out the £20,000 yearly allowance.
What’s the catch? Well, a stocks and shares ISA can only be topped up with £20,000 per year so if you want to accumulate wealth quickly in the stock market, you will need to use a general investing account too. And if you withdraw anything from the ISA, this does not deduct from your deposited total.