Dividend Shares - ISA or not?

[steveal]

My wife and I are in our late 60s and retired.
We live on a mixture of pensions and investment income.
We both have ISAs and we have a dealing account. Each ISA account and the dealing account are about the same size.
Each April we fully fund our ISAs from the dealing account.

Our question is, as we transition to dividend paying shares, should they go in the ISAs or in the dealing account?

At first it seemed obvious to use the ISAs, as the dividends will be tax free. On the other hand we are putting money IN to the ISAs each year, it seems strange to be also taking it out in dividends also...

[nmdhqbc]

Each April we fully fund our ISAs from the dealing account.
...
we are putting money IN to the ISAs each year, it seems strange to be also taking it out in dividends also...

So I assume you sell £20k worth of investments in the dealing account to re-invest inside the ISA? Why not sell £20k plus the dividend amount paid within the ISA and re-invest the total amount inside the ISA and "pay yourself" the ISA dividends amount from the dealing account. That way you shelter as much as possible from tax.

I may well have done a bad job of explaining that.

[staffordian]

Each April we fully fund our ISAs from the dealing account.
...
we are putting money IN to the ISAs each year, it seems strange to be also taking it out in dividends also...

So I assume you sell £20k worth of investments in the dealing account to re-invest inside the ISA? Why not sell £20k plus the dividend amount paid within the ISA and re-invest the total amount inside the ISA and "pay yourself" the ISA dividends amount from the dealing account. That way you shelter as much as possible from tax.

I may well have done a bad job of explaining that.

I understand it, and it's exactly what I did when trying to shelter non ISA stuff. I didn't take anything out of the ISA, but spent the dividend equivalent from my non sheltered portfolio.

On the OP's question of what to sell?

One thing I would weigh up when looking what to sell is what has gained the most.

If anything should change and you need to sell a significant amount of non sheltered investments then CGT might raise it's head, so systematically pruning those with the biggest gains might pay dividends, so to speak. And the same issue could arise if one of your big gainers were to be taken over, as has happened recently with Greene King.

[tjh290633]

My wife and I are in our late 60s and retired.
We live on a mixture of pensions and investment income.
We both have ISAs and we have a dealing account. Each ISA account and the dealing account are about the same size.
Each April we fully fund our ISAs from the dealing account.

Our question is, as we transition to dividend paying shares, should they go in the ISAs or in the dealing account?

At first it seemed obvious to use the ISAs, as the dividends will be tax free. On the other hand we are putting money IN to the ISAs each year, it seems strange to be also taking it out in dividends also...

It makes more sense for dividend paying shares to go in the ISA, where they are free of income tax and capital gains tax.

On the other hand, you have an annual Capital Gains tax allowance, so you can afford to take money out of your dealing account by using your CGT allowance, first to fund your ISA and second to provide an income. You also have an annual dividend allowance, so you can have up to that limit of dividends in your dealing account and pay no income/dividend tax.

Ideally everything is inside the ISA tax shelter, as then you do not have to account for anything to the HMRC.

TJH

[JohnB]

Your £2k dividend allowance means you don't need to shelter £50k of shares if they pay 4%. The £11kish CGT allowance is more generous, as you'd need a lot more shares to get a gain that much a year.

So on that basis dividend shares should be in the ISA, growth shares outside. But I agree there is no reason to take dividends out of an ISA when you can just sell more unsheltered.

For funds/ETFs, buy ACC units for the ISA, INC units outside. The former avoids quarterly reinvestment costs, the latter simpler tax returns.

If you have larger savings, fix up to £11k a year of capital gains a year by selling, and you don't need to do a tax return calculation for them (if selling more than £44k, you do need to do the calculation, even if the gain is below £11k), you never know when you want to liquidate your holdings, and its best not to have capital gains hanging over you.

[Lootman]

One frustrating thing about trying to make decisions like this is that the tax rules keep changing. In the time I have been investing we have:

1) Gone from having tax withholding on dividends to having tax credits on dividends to having limits on the amount of dividend income you can receive tax free.

2) Capital Gains Tax has gone from being at 40% with indexation, to being 18% with no indexation, to being 10% and 20%, on shares.

So the answer to the question might have varied depending on when it was asked. And will likely change again in the future. But in any event I think the real question to ask is whether you have more of an income tax problem or a CGT problem. Back when I was working and had a smaller portfolio, it was income tax that concerned me. So I'd stuff the dividend-paying shares in my ISA and had the growth investments in my taxable account.

But then when I retired and after I had a couple of windfalls, I suddenly had growing amounts of unrealised gains, but my income tax liability dropped. So I changed the emphasis with iSAs attracting the growth securities and dividend shares went in the taxable account.

Think about it this way: If you have a million pounds in a taxable account, and it yields 4%, then you are still only in the basic rate band of income tax. But the market only has to go up by 1.2% a year to effectively use up a year's CGT-free allowance. So for larger amounts I think it is CGT you want to shelter from tax, and not dividends.

[steveal]

Think about it this way: If you have a million pounds in a taxable account, and it yields 4%, then you are still only in the basic rate band of income tax. But the market only has to go up by 1.2% a year to effectively use up a year's CGT-free allowance. So for larger amounts I think it is CGT you want to shelter from tax, and not dividends.

Lootman, I'm not sure your comparison is valid. The 4% yield has you paying plenty of tax, the 1.2% move has you paying none?

[Lootman]

Think about it this way: If you have a million pounds in a taxable account, and it yields 4%, then you are still only in the basic rate band of income tax. But the market only has to go up by 1.2% a year to effectively use up a year's CGT-free allowance. So for larger amounts I think it is CGT you want to shelter from tax, and not dividends.

Lootman, I'm not sure your comparison is valid. The 4% yield has you paying plenty of tax, the 1.2% move has you paying none?

I think it depends how you look at it. I agree you'd pay no CGT in my example, at least if you didn't sell anything. But you are really just deferring the CGT if you never sell. What concerns me is if the growth in unrealised gains exceeds the annual CGT allowance which, in my situation, has been the case for most of the last 20 years. And that is why I prefer capital growth in my ISA, to avoid a massive future CGT liability.

Meanwhile the dividends in my taxable account represents most of the money I I live off, so there is really no alternative to having to pay the income tax on those anyway. (Unless I want to reduce the amount that is tax-sheltered by withdrawing from my ISA, which I do not).

i think the instinct of most people is to want to shelter income in an ISA. But there are some circumstances where that doesn't seem optimal to me. Of course I do assume that most growth comes from lower-yielding securities. Again that has been my experience but others may differ.

[Gerry557]

Not knowing your full circumstances its always difficult but generally I would be putting the divi paying shares into the ISA and transferring the lower yielding later depending on CGT implications which hopefully you do have the facts to see for yourself.

I too would build up the ISA cash dividends then sell something outside the isa (and rebuy if necessary in the ISA) or use the sale for any cash requirements so your tax free amount is growing and your tax paying reduces over time.

There will be some charges doing this, dealing, stamp etc but in the longer term it should make sense. You might even have access to cheap dealing times with your broker, if that in itself is not the cheapest for your circumstances.

There are some allowances as others have mentioned so see what works out best for you but generally YES!

[steveal]

Thanks to everyone who replied and clarified my thoughts.

To sum up:
1. The ideal situation is all our investments in ISAs.
2. With that in mind, taking dividend income out of an ISA is not on.
3. Instead, each year liquidate from the non-ISA account and amount equal to the ISA allowance plus any ISA dividends . Transfer the full allowance into the ISA and spend the "ISA dividend".
4. As a general rule, dividends in ISAs are good, but beware capital gains issues in the non-ISA accounts.

This will tie in quite nicely with our situation.
Our non-ISA 'income' is mainly the fruits of option selling. It is therefore a capital gain in reality and for tax purposes. However, we STILL have capital losses being carried forward from 2001-2003 etc.!

[jaizan]

I agree with the last post and do something similar myself (with 1 ISA)
Move all the dividend payers to the ISA. Reinvest the dividends within the ISA and let this roll up for as long as possible.
A little bit of calculation may be necessary, as ideally you would want to minimize capital gains tax liability when selling and get near to your CGT allowance each year. I actually had a yield/capital gain ratio in the spreadsheet when deciding what to liquidate from the taxed account to fund the ISA plus living costs (and a SIPP top up at the end of the previous tax year, when still employed).
Also bear in mind the £2k tax free dividend allowance.

The final caveat is living off the dividends is only safe for conservative sustainable dividends from good solid companies. If there is a temptation to chase too high a yield, the risk of dividend cuts and loss of capital can increase. So living off the dividends is to some extent an arbitrary limit.
I'm still planning to spend less than 3% of assets each year.

[Dod101]

The only thing wrong with the argument about selling some shares outside of the ISA equivalent to your living expenses is that it might well unbalance your portfolio. It would also need a big change in my mindset to do that because quite a number of my unsheltered holdings are shares I have held for more than 20 years. They have big capital gains well over the annual limit if I sell anything like enough to live off. In any case, they are shares I want to keep. Living off the dividends means that the portfolio is undisturbed. I usually sell only if my portfolio is getting very unbalanced and then of course I have some cash which I sometimes keep as living expenses.

I nowadays find myself with surplus dividend income from time to time and occasionally reinvest the dividends in an ISA but not as a rule.

I also deliberately keep some shares in certificated form (I have only a very small trading account balance and use the trading account to occasionally sell all or part of a certificated holding.) because it means that I am not at any risk of problems with the platform with these shares.

Dod

[monabri]

My wife and I are in our late 60s and retired.

I'm going to be upfront on this...sorry..it's a fact of life...or death. Isn't it the case that if one of you were to die, one can have the other's ISA'd shares transferred to preserve the tax status? If the dividend paying shares were not ISA'd, then the living partner would have an increased tax bill.

[monabri]

My wife and I are in our late 60s and retired.

I'm going to be upfront on this...sorry..it's a fact of life...or death. Isn't it the case that if one of you were to die, one can have the other's ISA'd shares transferred to preserve the tax status? If the dividend paying shares were not ISA'd, then the living partner would have an increased tax bill.

miserable git!

[monabri]

Oh, I forgot..Merry Christmas !!

[Dod101]

My wife and I are in our late 60s and retired.

I'm going to be upfront on this...sorry..it's a fact of life...or death. Isn't it the case that if one of you were to die, one can have the other's ISA'd shares transferred to preserve the tax status? If the dividend paying shares were not ISA'd, then the living partner would have an increased tax bill.

Strictly speaking I think it is more accurate to say that the surviving spouse is granted a special kind of ISA equivalent in value to the value of the deceased spouse's ISA(s) at date of death. Obviously whether or not the assets in the deceased spouse's ISA9s) are transferred into it is a matter for the Will and whether the survivor wants a transfer in specie.

So it is in fact the tax status that is preserved not necessarily the assets held.

Dod

[stressor]

Here is a projection, I am not a financial advisor, I am just working this out on the back of an envelope, someone please correct me if I am wrong! I am going to have to start with some assumption unless you give me actual figures. I am going to run a model based on 5yrs and 10yrs, and you withdraw you money only at the end.

Portfolio starting capital: 50k
Annual investment: 20k
Annual return 4% (conservative assumption, typical of private investor)
Dividend tax @ 32.5% (rate varies)
GCT@20% (rate varies)
Broker fees + stamp duty on 5x trades per year built in
All gains and dividends compounded until the day you cash out.

RETURNS IN AN ISA:
Year 5 = £195k
Year 10= £314k

RETURNS NOT IN AN ISA
Year 5 = £162k less CGT (£1,700) = £157k
Year 10= £291k less CGT (£6,850) = 277k

As you see there is a modest difference in vs out of an ISA *when gains are modest* the efficiency savings in the ISA are around 13% (314/277)....but lets re-run the figure with gains of 10% per year;

RETURNS IN AN ISA:
Year 5 = £202.6k
Year 10= £448k

RETURNS NOT IN AN ISA
Year 5 = £173k less CGT (£5k) = £168k
Year 10= £347k less CGT (£20k) = £327k


As you see there is a large difference in an ISA *when gains are large* but it would be hard to average 10% portfolio growth per year for 10 years for sure. In fact the difference of 448k to 327k is 37% more efficient in the ISA over 10years with all the above assumptions.