Dividend Allowance Changes: How It Might Shift Your Income Strategy

Changes to dividend allowances can be particularly frustrating for investors with a lower risk appetite. Unlike growth stocks, equities that pay dividends are often seen as a stable investment that can help to provide a steady income stream over time. 

As recently as the 2016/17 tax year brought a dividend allowance of £5,000. However, this was cut to £2,000 for 2018/19 before halving to £1,000 in 2023/24. 

Finally, for the 2024/25 tax year, the maximum tax-free income you could receive from dividends fell to £500, where it’s stayed until today. 

If you receive a dividend income of more than £500 this tax year, your earnings will be taxed at 8.75% if you’re a basic rate taxpayer, 33.75% for higher income earners, and 39.35% for additional rate taxpayers. From April 2026, though, dividend rates rise from 8.75% to 10.75% for basic rate taxpayers and from 33.75% to 35.75% for the upper rate.

Reporting Dividends

It was estimated that the number of investors paying dividend tax for the 2024/25 tax year reached 3.7 million, according to HMRC data. Astonishingly, this is double the amount of UK individuals recorded just two years prior due to the aggressive cuts to the dividend allowance. 

With this in mind, many residents will find themselves declaring their dividends to the taxman for the first time, so what process should taxpayers follow? 

Once your payouts exceed your £500 dividend allowance, you’ll have to declare them to HMRC. This generally involves filling in a Self Assessment tax return, where you’ll just need to declare the dividend amount on your form. 

If you don’t use self-assessment tax returns, you can either notify the HMRC by calling 0300 200 3300 or by asking them to update your tax code to deduct your dividend tax using an online contact form. 

Overcoming Dividend Tax

If you’re an investor who is eager to make your dividend payouts stretch as far as possible, one of the most effective options available is to make the most of a stocks and shares ISA. 

The great thing about Individual Savings Accounts is that they allow you to make investments in an entirely tax-free way. This means that you can use your ISA to hold stocks and shares within a portfolio and pay no capital gains tax (CGT) or any other form of income tax on the money you make. 

Crucially, you also won’t be liable to pay any dividend tax on any dividend payouts that occur within your ISA, and they won’t have any effect on your £500 annual dividend allowance. 

The only catch with ISA investments is that you’re only allowed to deposit £20,000 across all your accounts during each tax year, which may be limiting if you typically invest significant amounts into dividend stocks. However, with the benefit of compounding dividend payouts, you can grow your holdings significantly each year to incorporate more dividends into your investment strategy. 

If you regularly invest more than £20,000 per year, you may even find it beneficial to allocate your ISA towards dividend stocks, with other portfolios dedicated more to growth stock investing, so as to maximise your tax efficiency. 

Growth as an Alternative Solution

Dividend payouts are generally associated with lower-growth stocks that are typically more resilient and stable in the face of fluctuating equity markets. This can suit plenty of investors with a low risk appetite. 

If you’re an investor who’s willing to take on more risk, however, you may find that you can replace your dividend income with greater gains by holding growth stocks instead. 

Growth stocks have been on a tear in recent years, with the tech stock-heavy S&P 500 returning 26% and 23.31% in 2023 and 2024, respectively. 

If these bullish trends continue, it may be possible to return a profit that exceeds the rate of dividend growth investors can receive even when taking compounding into account. But the associated risk is greater. 

It’s also worth noting that the CGT allowance has also been reduced to £3,000 for the 2025/26 tax year, meaning that you’ll still have to pay out on any growth your portfolio benefits from, (unless you’re holding your investments in a tax-free wrapper such as an ISA). 

Finding Sustainability

The risks of lower dividend tax thresholds are clear. If you don’t receive substantial dividend payouts, you may find that your investment strategy has been undermined. 

Fortunately, there are plenty of options that can help you to continue benefiting from dividends or wider investment opportunities by using ISAs or opting instead for growth stocks. Still, ultimately, there’s no right or wrong answer when it comes to adapting your income strategy in the face of changes to tax laws. 

Be sure to assess your risk appetite and financial goals before choosing the best way to adapt your investment strategy. If you’re struggling to decide on your next moves, it may be worth asking your financial adviser for some fresh insights.