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Dividends can be a valuable source of income. Investors are increasingly interested in them in 2022 as more households face the rising cost of living. Yet what are dividends, exactly, and how can they be put to work in a portfolio? Below, our Burnley financial planners offer a short guide to dividends in the 2022-23 tax year and where they can help facilitate financial goals. We hope this content is useful to you and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
What are dividends?
Dividends are payments made from a company to investors out of company profits. They are not obliged to be distributed to shareholders, but companies often have an incentive to build up a strong reputation as reliable dividend-payers. This can be a valuable way to attract and retain investors, especially for larger companies which have already solidified their position in the market (making it difficult to grow their share price via expansion).
Investment funds can also pay dividends. Here, investors’ pool money together into multiple dividend-paying companies, helping to spread out investment risk and access more frequent payments for investors. Dividends can be paid by companies at various regularities and times of the year, such as quarterly or once every six months.
Benefits & drawbacks of dividends
One key advantage of dividends is that these regular payments can help to facilitate an income (e.g. from a salary). Even a £100 average monthly dividend payment from your investments could be a welcome boost to your finances. Moreover, the companies likely to pay dividends are often large, established businesses with fairly stable share prices. If reducing volatility is a key goal for your portfolio, then dividend stocks can be a good option (perhaps alongside cash and bonds). Dividends are also subject to a different tax rate from income tax – opening opportunities to increase your overall income in a tax-efficient way. In 2022-23, dividends are taxed at 8.75% (basic rate), 33.75% (higher rate) and 39.35% (additional rate). Their corresponding income tax bands, conversely, are 20%, 40% and 45%.
However, dividends are not risk-free. Dividend-paying stocks (and funds) can still experience a share price fall or collapse, perhaps due to a significant change in the market or government regulation. Companies are also not guaranteed to pay dividends, and can leave investors out of pocket. In 2020, for instance, over $220 billion of global dividends were cut as companies fought to protect their business from the pandemic (retaining more profits rather than distributing them). Many of these companies had even reliably paid out dividends in the past, taking investors by surprise. Dividend-paying companies and funds are also often limited in their growth potential, since their markets have already become saturated. This can make them a less attractive option for investors looking to build growth over the long term (e.g. to grow a future retirement fund).
Strategic considerations for dividends
Before rushing to dividends, the first question to ask yourself is what your goals are. Are you mainly looking to boost your short-term income (e.g. to help with the cost of living)? Dividends can help here, but unless you have a large sum ready to invest into dividend investments it may take a while to build up a portfolio which pays a meaningful dividend income. For instance, suppose you want a £200 average monthly dividend income. Assuming a 3% average return, your portfolio of shares and funds might need to reach £60,000 to start achieving these figures. For company directors, it may be easier to justify taking £2,400 each year from company profits as dividends. However, you should first carefully check whether this can be done without risking the stability of the business.
Those who are attracted to the idea of dividends should consider how to incorporate them in the most tax-efficient manner. In 2022-23, each person is entitled to earn up to £2,000 per tax year in dividends without facing tax. If you are in danger of exceeding this threshold, then one option could be to build up your dividend-paying investments in an ISA. You can commit up to £20,000 per year into your ISA account(s) and generate dividends, and capital gains, without tax. Those with a partner might also consider transferring assets to them if their tax-free dividend allowance for the tax year has not been fully used (especially if they occupy a lower income tax band). If you are married or in a civil partnership, you can usually give or sell assets to your partner with no capital gains tax implications.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
