Isa guide 2016: As the dividend tax regime changes, here's what income seekers need to know

Will Railton
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The new Dividend Allowance will complicate things for income-seeking investors (Source: Getty)

In this year's Budget, George Osborne tinkered with Isas yet again. Since becoming chancellor, he has increased the tax-free allowance a number of times (no bad thing), but he has also launched a raft of variations which cater to different, but not necessarily distinct, savings goals.

As the Isa grows more complex, here's how income seekers can navigate the maze.

Why things are getting complicated

Dividends can be of real benefit to investors, and not only if you're a retiree using regular payments as a source of income. “If you’re starting off, time is on your side and you need to be reinvesting dividends and bond coupons to benefit from the power of compounding,” says Russ Mould, investment director at AJ Bell.

Until now, Isa has been a favoured vehicle for shielding income-paying stocks from tax. But a major change to the dividend tax regime is about to complicate things for income seekers.

When it comes into effect on 6 April, the Dividend Allowance will allow you to earn £5,000 a year in dividends tax-free, outside of the Isa wrapper.

How will this affect income seekers?

The new Dividend Allowance has left many wondering whether it would be better to reserve their Isa solely for growth and leave income-paying assets outside. But this is not necessarily the case.

Anyone reliant on dividend income will welcome the tax break. But there are risks to keeping your investments outside the tax-free wrapper. Indeed, there is high tax on any dividends over the £5,000 mark – 32.5 per cent for higher rate taxpayers and 38.1 per cent for additional rate taxpayers.

You could also face capital gains tax if you choose to rebalance those assets at a later date. Even with recent reductions, higher and additional rate taxpayers must pay 20 per cent on any gains over £11,100.

And of course, there’s no guarantee that a tax won’t be reimposed on those assets in future.

“It would be easy for the current or a future chancellor to increase investor taxes,” says Danny Cox of Hargreaves Lansdown. “Money sheltered in an Isa is far better protected from budgetary tinkering.”

This article appears in the March edition of City A.M.'s Money magazine, which will be distributed with the paper on Thursday 31st March.

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