A record 317 million people will be affected by the dividend tax squeeze; learn how to safeguard your investments

The reduction of dividend tax allowances is estimated to have forced an additional 113 million taxpayers to pay the levy over a two-year period, with basic rate taxpayers bearing a disproportionate amount of the burden

In the 2024 - 2025 tax year, it is anticipated that the number of individuals paying dividend tax will have increased to a record 31.7 million, as millions of new taxpayers are drawn into the tax system by reduced allowances.

You pay a tax on your investments known as dividend tax. In contrast to capital gains tax, which is paid on investments that are sold for a profit, dividend tax is paid on the dividends that your investments generate.

Dividends are subject to an 8 percent tax rate for taxpayers with basic rates. It is 33.75 percent for taxpayers with higher rates. Taxpayers who pay additional rates pay 39.35 percent.

Only dividends over £5,000 were subject to dividend tax in previous years. By 201718, this had dropped to 2,000. The tax-free dividend allowance was subsequently cut in half to 500 in April 2024 after being further lowered to 1,000 in 2023.

HMRC data that Quilter obtained through a Freedom of Information (FOI) request showed that the number of dividend taxpayers increased from 1point 9 million in 2022 - 2023 to an estimated 3point 08 million in 2023 - 2024. For the 2024 - 2025 tax year, this amount is anticipated to increase even more to 3.67 million.

The reduction in the allowance to 500 is estimated to have made an additional 865,000 people eligible for dividend tax in 2023 - 2024 and an additional 480,000 in 2024 - 2025. Over the course of the two years, that amounts to an additional 1.25 million taxpayers.

Quilter.

Rachael Griffin, a tax and financial planning specialist at Quilter, says, "These numbers demonstrate just how subtly but successfully the tax net is growing."

What is the government's dividend tax revenue?

Since incomes have increased, millions of investors have been forced into higher tax bands, where they have been hit by frozen tax thresholds, also referred to as stealth taxes. The phenomenon of dividend tax thresholds being lowered is comparable.

According to Quilters data, HMRC's most recent projections indicate that the April 2024 cut was expected to raise 450 million in 2024/25, 810 million in 2025/26, 860 million in 2026/27, and 940 million in 2027/28.

Griffin stated, "The Government has stated that it anticipates generating hundreds of millions of dollars in extra revenue as a result of these changes, and the data indicates that it is making good progress in this regard." The complexity of compliance is increasing, especially for people who are not familiar with the tax system, so the cost is not only monetary.

According to AJ Bell's separate FOI request, HMRC anticipates collecting 18 point 6 billion in dividend tax in the 2025 - 2026 fiscal year.

Dividend tax: who is responsible for it?

An increasing number of low- and medium-income taxpayers are now subject to the dividend tax allowance due to its reduction.

"Millions of regular investors, many of whom are basic rate taxpayers, are now impacted by what was once a niche tax that only affected a relatively small group of higher earners and business owners," says Griffin.

In 2024 - 2025, 1 million individuals in this tax bracket are anticipated to owe dividend tax. For many of these, this will be their first-time experience.

Griffin states that "this will have come as a surprise," particularly if they only have small investments outside of pensions or ISAs.

Dividend tax will now be paid by nearly a fifth of all higher-rate taxpayers, with an average bill of £6,202 per person, while additional rate taxpayers will see an average bill of £28,879, according to AJ Bell.

Would it be possible to eliminate the dividend tax allowance?

Investors may be in for more suffering. In a March leak, deputy prime minister Angela Rayner's memo to the Treasury suggested raising the dividend tax paid by the wealthiest investors and doing away with the dividend tax allowance entirely.

Nonetheless, the dividend tax allowance is believed to remain unaffected when the Autumn Budget is presented.

According to Sarah Coles, head of personal finance at Hargreaves Lansdown, "it would be counterintuitive to make dividend investing less rewarding given that the government is keen to encourage investment in the UK, given how attractive the UK market is for investors seeking dividends."

Additionally, considering previous reductions, the amount of money the government could raise by eliminating the remaining allowance is limited.

Chief investment analyst Rob Morgan of Charles Stanley stated, "A further cut is not going to raise significant revenue, as the dividend allowance has already been slashed almost to a vanishing point." However, it could easily happen if this budget is just a matter of searching the back of the sofa for any spare change that exists.

How to avoid paying dividend taxes on your investments.

Utilizing tax-efficient wrappers, like ISAs, is the most crucial method to guarantee that your investments are free from dividend tax.

"It has never been more important to make full use of ISAs, pensions, and other tax-efficient wrappers," says Griffin.

Make sure to utilize your yearly 20,000 ISA allowance to the fullest because any investments made in stocks and shares are exempt from capital gains or dividend taxes.

It is feasible to accumulate a sizable portfolio of tax-sheltered investments by "utilizing as much of the annual ISA allowance of 20,000 each year as you can," according to Morgan. Additionally, the tedious administration associated with filing tax returns or HMRC reporting can be decreased or eliminated.

Your pension investments are no different. You can accrue dividends in a SIPP or here without depleting your dividend allowance.

Despite being generally high-risk investments, venture capital trusts (VCTs) are likewise exempt from dividend tax. However, they have the added benefit of providing upfront tax relief of 30%.

If you are able, you can also divide your allowances with your spouse to lower your tax liability. Morgan comments, "If you are married or in a civil partnership, you can also think about dividing income-producing assets, either by holding them in joint names or allocating them to the partner with the lower income and tax liability."