What last week's tax change means for you

The Government’s change to National Insurance and dividend tax rates last week means that most of us will end up paying more in tax. However, there are some things you can do to counter this. Here are the top things that you need to know about the changes.

More people will be caught by this than by National Insurance at present. At present, only employees up to state pension age pay National Insurance - they are then able to work without attracting this tax on their earnings.

The new tax, which starts next April, and will eventually be badged separately on your pay slip as a Health & Social Care Levy, means everyone under state pension age will pay 1.25 per cent extra of their income over a base level to fund the NHS and social care. 

For the first year of its operation – between April 2022 and 2023, only those under state pension age will pay this and it will be shown on pay slips under National Insurance. After April 2023, however, those who work who are above state pension age will also pay the 1.25 per cent, which will appear separately on payslips. The levy will apply to earnings over the base threshold for paying National Insurance – which is currently just over £9,500 a year but this could change.

Both the employed and self-employed are affected by the increase, but voluntary National Insurance contributions for those who are trying to catch up on years they have missed paying the tax will not be affected.

Many investors will be caught by

As well as raising NI, the Government raised dividend taxes by 1.25 percentage points. This means that those who are self-employed and pay themselves a low salary but top it up with dividends through their limited company to save tax will also see their taxes rise.

However, those who receive income from dividends on investments are also liable for the tax.  Everyone can receive £2000 a year from dividends without paying tax, but after this, higher rate taxpayers pay 33.75%, up from 32.5 per cent, while basic rate taxpayers pay 8.75 per cent up from 7.5 per cent. Additional rate taxpayers pay 39.35 per cent, up from 38.1 per cent.

Many people will be hundreds of pounds worse off a year

According to the Government’s own impact assessment on the tax change many  of us will feel the pinch. Next year, an average (median) basic rate taxpayer earning £24,100 will pay an extra £180 in tax while a median higher rate taxpayer on £67,100 will pay £715 more.

Those taking £20,000 of dividends from their investments would pay an extra £225 a year in dividend tax after the increase.

There are some things you can do to bring the cost down

While employees and employers must pay National Insurance on their income, there are things you can do to bring down the cost. Making higher pension contributions through a salary sacrifice scheme means that they come out of your income before National Insurance is paid, while your employer may offer other benefits that come out of your income before tax through salary sacrifice, such as the option to purchase an additional holiday, healthcare or transport options such as season tickets, bikes, and electric cars.

As an investor, the most sensible thing to do is to move all investments you can into tax wrappers as soon as you can. Any investment in an ISA or pension does not attract tax on dividends and you can put £20,000 a year into an ISA and £40,000 a year into a pension.

Advisers often use a system called ‘Bed and ISA’ when investors have portfolios that need to be moved into tax wrappers. This involves selling the assets than buying them back again in an ISA immediately.

If you are self-employed through a limited company and pay yourself through dividends, making your spouse a director of your limited company and paying dividends to you both may be an option to cut down the tax rate, while paying your pension contributions from the company will also help.

If you’re unsure about how this will affect you or what to do next, consulting a financial adviser or your accountant is a sensible next step.

1 https://www.gov.uk/government/publications/health-and-social-care-levy/health-and-social-care-levy