A 2% increase to the basic and higher rates of dividend taxation is expected to come into effect from April 2026. The basic rate will increase to 10.75% (from 8.75%) and the higher rate to 35.75% (from 33.75%).
While a 2% rise might sound manageable in isolation, it must be viewed in context. It creates a significant cumulative impact for Company Directors (some already being squeezed at the other end by rising Corporation Tax) who rely on drawing business profits as dividends, and for investors who receive dividends as part of their investments, either as withdrawn or reinvested income.
The dividend allowance has reduced over the years to just £500 per person per tax year. Alongside frozen tax bands expected until at least 2031, the increased overall rate of tax tightens the squeeze on those with increasing remuneration or those looking to grow their investments. The effect is more tax on the same money, which is already being challenged with less purchasing power due to inflation.
Over time, the “tax drag” on investment returns becomes more severe. Investments held outside of beneficial “wrapper” accounts such as ISAs, pensions, and even Investment Bonds, will experience reduced returns as they will have more tax to pay depending on the type of wrapper and timing of withdrawals.
Increasing changes to the tax treatment of investments mean it is no longer enough just to make sure you are using your annual allowances effectively. Choosing the right underlying investment within the right type of account becomes more critical if you are going to stay ahead.
What You Can Do About It
The most immediate step is to maximize tax wrappers, which may involve the annual Bed and ISA transaction to switch from a non-ISA account to an ISA.
For those with larger portfolios, other efficient long-term solutions are more relevant. Investment Bonds (both onshore and offshore) seem to be becoming increasingly attractive again. Unlike a standard share portfolio where dividends are taxed annually whether you spend them or not, an Investment Bond allows you to defer the tax.
You can switch funds within the wrapper without triggering a tax charge, and you can make cumulative withdrawals of up to 5% of your original capital each year tax deferred. This allows you to control the timing of your tax liability, perhaps waiting until you are a basic rate taxpayer in retirement to encash the segments.
There are further advantages to Investment Bonds to consider, such as the potential ability to use them for tax-efficient gifting as part of a strategy for mitigating eventual Inheritance Tax.
My View
In my view, this creates a complex landscape where investors may feel forced to make decisions based on tax mitigation rather than pure investment merit. The risk is an investor can lose sight of their goals, which should always drive investment decisions based on the most suitable after-tax outcome.
The best place to start is to understand the impact by modelling your current financial setup. This helps to identify where to concentrate your time and effort, and where professional help may have the most impact. From there the rest will fall into place; often the required actions can be relatively simple. The result is more value from your investments and that elusive peace of mind, knowing you have done everything you can to stay ahead.
