If you’re a company owner, contractor or freelancer working through a limited company or an investor then you are probably already aware of the changes to the dividend allowance that are happening from the 6th April 2018.
Just to recap, dividends are a way of sharing out the profits made by companies. For people working through a limited company it can be a much more tax efficient way of paying yourself.
Currently you can be paid up to £5,000 per tax year in dividends without incurring any direct Income Tax. This is called the dividend allowance. Any additional dividends paid above this are subject to dividend rates of Income Tax.
From the 6th April the dividend allowance will reduce to £2,000, a 60% reduction!
But if you think it’s just a case of paying a bit more tax due to the loss of some of the dividend allowance, think again.
What to watch out for when the dividend allowance changes
If you decide to increase your dividends to make up for the extra tax you will be paying because of the dividend allowance reduction, then this could have implications if you or your partner are receiving Child Benefit.
Child Benefit is lost if you or your partner earns more than £60,000 and is reduced if you earn between £50,000 and £60,000.
So if your total earnings including dividends were previously £50,000 and you decide to increase this to £55,000 you will lose 50% of your Child Benefit.
Worse still if your partner is not working and stops claiming Child Benefit they will not receive a credit towards their State Pension.
Pensions are a great way to save Tax and essential for company owners and contractors who have no employer to pay in on their behalf (more on this later).
But the rules on how much you can contribute to pensions have become very complex in the last few years and penalise high earners.
If your earnings (including dividends) plus pension contributions made by your company are over £150,000 then the amount you can pay into a pension will be reduced (called the pension Tapered Annual Allowance). If you’ve already made a pension payment without checking, you could find you now need to pay extra!
Again if you decide to increase the amount of dividends you receive you could find that this small change takes you over the £150,000 threshold.
Other investments that pay dividends
Whilst you may reduce the amount of dividends you receive when the new dividend allowance kicks in don’t forget that if you hold other investments, they may pay you dividends as well, meaning you are still over the new dividend allowance and therefore still paying more tax.
How to protect against the new dividend allowance implications
So what can you do to protect yourself against these hidden implications?
Well there are lots of solutions and a good Chartered Financial Planner will be able to come up with some very valuable strategies for you.
For now here are 3 ideas.
- Pension contributions
If you are not affected by the Pension Tapered Annual Allowance rules then pension contributions through your limited company can still be a really great way to save lots of tax.
Company pension contributions are an expense and therefore paid before profits are calculated so saving you Corporation Tax, National Insurance and Income Tax.
Better still, the money grows tax free inside a pension and pension contributions are a good way of reducing your income for Child Benefit purposes.
- Tax wrappers
If you’re investing your money make sure you use a tax efficient wrapper like an ISA.
Any dividends you receive from an ISA are tax free and do not impact on things like the dividend allowance, Child Benefit and the Pension Tapered Annual Allowance.
- Additional shareholders
Does your partner own part of your company? Do they carry out tasks for your company?
Why not make them a shareholder and start paying them a dividend?
This way you get 2 x dividend allowance.
The key thing is to get planning and making sure you are not caught out by not knowing what you don’t know!
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.