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Why record income tax means investors should consider a Stocks and Shares ISA

Dividends are an important source of investment returns. We look at how you can use an ISA to make sure you’re not paying more tax than you need to.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Nadeem Umar
Research Editor

Published on 24 February 2020

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Last year investors received a record £110.3 billion in dividends, a jump of 10.7% over 2018.

This is great news for investors, who have been able to withdraw more income without eating into their investments. Dividends can also be reinvested to help growth over the long term.

However, it’s likely that more investors than ever will have to pay income tax on their dividends. What’s more, the dividend tax allowance, the amount of dividend income you can receive before you have to pay tax, was cut from £5,000 to £2,000 in 2018.

This article is not personal advice. If you're not sure whether an investment is right for you, please seek advice. All investments and income can fall as well as rise in value so you could make a loss. Remember that tax rules change and benefits depend on individual circumstances.

What if I don’t pay tax now?

Even if you’re within the dividend allowance for now, don’t be lulled into a false sense of security. For starters, tax rules can change so there’s always the possibility that the government could cut this allowance again in future.

Although estimations suggest that dividends will be slightly lower in 2020, they’re still expected to be more than £100 billion. Rising dividends aren’t the only thing that could mean you pay tax in the future, as over the years you may add to your investments. Holding a higher value of income paying investments means you’re likely to receive more in dividends, although remember that dividends are variable and not guaranteed.

How to save income tax with an ISA

Within an ISA there’s no UK tax to pay on income or growth.

So, the simplest way to cut the amount of tax you pay in dividends is to use as much of your ISA allowance as you can each tax year.

You can shelter up to £20,000 this tax year. And although investing is best for the long term, you can normally withdraw money from an ISA whenever you like, and if you decide to invest with HL it doesn’t cost any extra to hold funds in an ISA, so the tax benefits are effectively free.

More about our Stocks and Shares ISA and charges

Shelter your existing investments from tax

A “Bed and ISA” is when you sell shares and funds outside of a tax shelter, and buy them back in an ISA. This helps you shelter up to £20,000 of your existing investments from tax in ISAs.

When you sell your investments as part of this process, it can trigger a capital gain or loss. So the Bed & ISA process can be a useful way to use your £12,000 capital gains allowance for the current tax year. Don’t forget, if you have made a loss on your investments, you can usually carry it forward to offset gains in future tax years.

Once inside the ISA, investments are free of UK income tax in future – and capital gains tax too.

More about Bed and ISAs