Tax on Investment Income | A Simple Guide

Tax on Investment Income A Simple Guide

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Investments, savings, and dividends are three closely related types of income concurrent with one another and the taxes are charged at their corresponding taxes. The latter two may technically be considered under investment. These terms may be used interchangeably, but in this article, Tax on Investment Income: A Simple Guide, UK taxpayers will get to know their subtle differences, what kinds of tax they are charged at, when they have to be paid, their allowances’ threshold, and how much taxes are imposed on them.

What Is Savings and Dividend Income?

Savings are the money a person can gain through interests, which may be obtained through banks, corporate bonds, gilts, building society accounts, National Savings & Investments (NS&I) products, local authority investments, permanent interest-bearing shares (Pibs), voluntarily purchased annuities, and open-ended investment companies (Oeics) or trusts.

Savings gain profits through interests whilst dividends are from shares of a company equity.”

Dividends, on the other hand, are the income that one earns from buying shares and investment trusts in a company. All the shareholders get distributions from the company’s net profit. The profit is calculated based on how many shares one has.

Types of Savings and Investment Income to Earn From

One may choose to grow their money through savings, dividends, share-based investments, and other options of investment products, like open-ended investment companies (Oeics) and unit trusts. Depending on the product they choose, savings or investments may either be taxed or tax-free.
Types of Savings and Investment Income to Earn From

A great way to avoid paying taxes on these incomes is by putting shares or stocks in tax-efficient National Savings and Investments (NS&I) products. NS&I changes its products from time to time. It offers both taxed and tax-free products, so one must be wary about the latest products it offers to get the best deals.

The two major products that NS&I offers include Individual Savings Accounts (ISAs), formerly called Personal Equity Plan (PEP), and Junior ISAs. ISAs are typically for adults whilst Junior ISAs are for children whose accounts are made by their parents or guardians on their behalf.

ISAs have four main various products that guarantee automatic tax exemption to any income, sales of assets, or dividends. Individuals may either choose to pay for one Individual Savings Account or spread their cash amongst all the ISA products, granted that the money they put in doesn’t exceed the £20,000 limit for each tax year.

Tax-efficient investments allow UK residents to grow their money through savings or investments without worrying about having to pay hefty taxes.

How Do Tax Affects Investment?

When looking for investment options, it’s essential to consider the taxes they entail as taxes can greatly affect how much return one receives from their investment.

Tax regulations, such as the allowances’ threshold, may vary in the years to come, so when planning to invest, it might be a wise precautionary measure to check HMRC’s updated information regarding taxes. In matters like this, investors may also want to consult financial or tax advisors to decide what is best for their situation and determine what kinds of taxes they may pay for.

How Do Tax Affects Investment?

Generally, there are three types of taxes charged on investments with distinct rules, rates, allowances, and entitlements, and they may depend on the means that one obtains them and how much their returns are. Namely, they are income tax, dividend tax, and capital gains tax (CGT).

Income tax is imposed on investment interests, such as from savings accounts, shared dividends, and peer-to-peer investments, granted that they are non-ISAs.

Dividend income tax, on the other hand, is imposed on the profits or dividends one obtains from investing in shares and stocks.

Finally, capital gains tax must be paid on the profits one obtains from disposing of or selling certain assets from investments, such as shares.

Any of these taxes greatly affect the returns that savers or investors receive from their investment. Higher-rate taxpayers, especially those who invest in non-tax-efficient products, are usually imposed with hefty taxes.

Putting their savings or investments in tax-efficient NS&I products, particularly ISAs, is their best option for trimming their taxable income aside from maximizing the use of their allowances. For instance, with ISA, additional rate taxpayers can get to keep up to £20,000 for themselves without being charged with tax.

When Does Tax in Savings and Investment Income Have to Be Paid?

Tax allowances apply to savings and investments income, endowed by the government to taxpayers to encourage them to save and invest more. These are Personal Savings Allowance (PSA), Capital Gains Tax Allowance, and Dividend Allowance, the latter one to be discussed further in the article.

Allowances let taxpayers keep a certain extent of their income on a given threshold.”

Each of these allowances have thresholds to a certain extent. When a person earns an income that goes beyond the threshold allowance imposed on a certain tax year, they will have to start paying taxes for the rest of the income they receive.

The rate of tax individuals is charged depends on which tax bracket they fall under. For the tax year 2021/22, basic rate taxpayers are given a Personal Allowance of £12,570 whilst higher-rate taxpayers are allowed to keep the money they earn if it is within £50,270.

Capital Gains Tax Allowance, on the other hand, is £12,300 for the tax year 2021/22. This means one can make many sales from their assets before they start paying CGT.

How Much Tax to Pay in Savings and Investments

As mentioned, once profits reach beyond a certain threshold, taxes will have to be paid wherein the rates depend on which tax band an individual falls under as well as what type of investment they are having. Take note that this doesn’t include ISA and its equivalents as they are, in any way, tax-exempt.

Taxpayers either pay income tax or capital gains tax on their savings and investments income. A rule of thumb for income tax is that it is progressive, which means that the more one earns, the more their tax rates will be.

How Much Tax to Pay in Savings and Investments

It’s important to note that employment and investment incomes are calculated separately, so even if their employment incomes are less than their Personal Allowance, they are still subject to paying taxes on their investment incomes.

Tax band tax rate Personal Savings Allowance (PSA)
Basic Rate
20%
£1 to £12,570
Higher Rate
40%
£12,571 to £50,270
Additional Rate
45%
£50,271 to £150,000

For the tax year 2021/22 and beyond, basic rate taxpayers are obliged to pay 20% of income tax for their earnings between £12,570 and £50,270. Higher rate earners pay 40% if their income is between £50,271 and £150,000. Additional rate earners, on the other hand, are obliged to pay 45% when their income exceeds £150,000.

It’s a little different for Capital Gains Tax, which goes as follows:

Tax band tax rate
Basic Rate
10%
Higher Rate
20%
Additional Rate
20% to 28%

For capital gains tax, profits are charged at 10% for the basic rate taxpayers whilst it’s 20% for the higher rate taxpayers. For the additional rate taxpayers, the rate varies according to what they are selling. Gains from residential properties are taxed at 28% whilst for chargeable assets, it remains 20%.

What Is Dividend Allowance?

Another means to trim one’s tax liabilities is taking advantage of dividend allowance. For the tax year 2021/22, the allowance is set at £2,000. The amount remains the same for the tax year 2022/23. Taxpayers can keep an amount to this extent within that tax year.

When Does Tax in Dividends Income Have to Be Paid?

One will have to pay income tax on their dividend income once it exceeds the threshold of Dividend Allowance, and as usual, depending on their tax band.

It’s crucial to report to HMRC once their dividend income surpasses the allowance so that they can start filing their Self-Assessment and pay their dues.

How Much Tax to Pay in Dividends

For the tax years 2021/22 and 2022/23, the rate at which the tax bands are charged at is as follows:

Tax band tax rate
Basic Rate
7.5%
Higher Rate
32.5%
Additional Rate
38.1%

How Is Tax on Investments Calculated?

Tax on investments is derived from the level of allowances an individual is entitled to, their extent of income, and investment type. The capital gains and interest profits are added, then subtracted with the applicable deductions.

Apparently, calculating investment taxes can be complex. To get the most accurate results, one should opt for the help of tax professionals or tax advisors. Beyond this article, Tax on Investment Income: A Simple Guide, Legend Financial is here to help every taxpayer work out their potential tax liabilities and understand their obligations better.

References

What tax do I pay on savings and dividend income? (n.d.). Retrieved from Law Incomes Tax Reform Group: https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-savings-and-dividend-income

Tax on savings and investments: detailed information. (n.d.). Retrieved from gov.uk: https://www.gov.uk/topic/personal-tax/savings-investment-tax

Types of saving and investment income. (n.d.). Retrieved from Which: https://www.which.co.uk/money/tax/income-tax/income-tax-on-savings-and-investments/types-of-saving-and-investment-income-anvzz7m4fkh9

How are investments taxed? (n.d.). Retrieved from Money: https://www.money.co.uk/guides/how-are-investments-taxed

Tax on savings and investments – how it works. (n.d.). Retrieved from Money Helper: https://www.moneyhelper.org.uk/en/savings/types-of-savings/tax-on-savings-and-investments

Long-Term vs. Short-Term Capital Gains: What’s the Difference? (n.d.). Retrieved from Investopedia: https://www.investopedia.com/articles/personal-finance/101515/comparing-longterm-vs-shortterm-capital-gain-tax-rates.asp

Investments and tax. (n.d.). Retrieved from Uswitch: https://www.uswitch.com/investments/investment-tax/

How do your investments affect tax? (n.d.). Retrieved from Royal London: https://www.royallondon.com/about-us/members/understanding-your-finances/news-and-insights/how-do-your-investments-affect-tax/

What tax do I pay on savings and dividend income? (n.d.). Retrieved from Law Incomes Tax Reform Group: https://www.litrg.org.uk/tax-guides/pensioners/what-tax-do-i-pay-savings-and-dividend-income

Savings and tax. (n.d.). Retrieved from Law Incomes Tax Reform Group: https://www.litrg.org.uk/tax-guides/savers-property-owners-and-other-tax-issues/savings-and-tax

What is investment tax? (n.d.). Retrieved from Go Cardless: https://gocardless.com/guides/posts/what-is-investment-tax/

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