Since the £5,000 dividend allowance was introduced on the 6th April 2016, the differences between an ISA and a General Investment Account (GIA) have been marginal for assets under a certain level. This is on the basis that Capital Gains Tax (CGT) liabilities could be managed annually, and no tax would be payable on dividends received if they were within the dividend allowance.
However, after just two years, the dividend allowance dropped to £2,000 on the 6 April 2018.
What does the drop in dividend allowance mean in real terms for those in receipt of dividend income? As an example, a typical balanced portfolio with a diversified blend of asset classes may receive 2% of the portfolio value in dividends; therefore a portfolio of £250,000 would receive £5,000 of divided income. In the previous 2 tax years this would have been within the dividend allowance and no tax would be payable. In the new tax year this would create a £3,000 liability to dividend tax at a rate of either 7.5%, 32.5% or 38.1% depending on whether the holder was a basic/higher or additional rate tax payer.
On the same 2% dividend yield basis with the £2,000 dividend tax allowance, the tax efficiency of a GIA is only up the value of £100,000. This will obviously increase if the dividend yield is lower or decrease if the dividend yield is higher.
So what options are available?
- Dispose of some of the assets within the GIA wrapper to keep within the dividend allowance. Consideration needs to be given to any CGT implications.
- Reduce the dividend yielding equities in the portfolio.
- Pay the dividend tax due.
- Transfer ownership of the assets to use a spouse or civil partners dividend allowance or to potentially pay dividend tax at a lower rate (or utilise their CGT allowance if disposing of assets).
Other considerations
If no new assets are available to top up the ISA annually, ensure the ISA limit is disinvested from the GIA to top up the ISA each year.
If the objective is to pay as little tax as possible and none of the above solutions achieve this then consider other investment wrappers. Investment Bonds for example could be the right solution, by investing within a bond which is a non-income producing tax wrapper, the investment exposure can be maintained without the ongoing annual tax concerns. By investing in a bond could not only increase the tax efficiency when accumulating wealth but could also give more opportunities to maximise tax allowances when de-cumulating wealth.