I have a question about SIPPs and dividends. My SIPP is geared to generate significant dividend income in retirement, but are the dividends classed as income, so rather than 8.75% tax I’d be liable for the 20% basic rate of income tax (as long as I don’t breach the £50,270 limit)?

I don’t want to sell my dividend payers, so the fact they are currently in a tax wrapper is irrelevant because I’m not intending to realise any capital gains. Is the solution to sell my holdings, move the cash into a trading account, buy the holdings back and then take the dividends? If so, how much can I move in a year, and will I have to pay tax?

Alan

Rachel Vahey, AJ Bell Head of Public Policy, says:

When thinking about how to build an investment portfolio to provide an income, many people turn to dividend stocks. These – held on their own or as part of a fund – will pay out a steady stream of dividends, allowing investors to share in the profits of the company.

If you receive these dividends through a trading account or general investment account, then you will pay dividend tax on anything over the tax-free allowance of £500 a year.

If you’re a basic-rate taxpayer you’ll pay 8.75% tax on your dividends, and if you’re a higher-rate taxpayer you’ll pay 33.75%. It’s 39.35% if you’re an additional-rate taxpayer.

However, the taxation is different if you hold these dividend producing shares within a pensions tax wrapper. To take them out to give you an income you will have to access or ‘crystallise’ the SIPP. 

You can access a pension from 55 (rising to 57 from April 2028). Of any money you take out, up to 25% will be tax-free and the remaining 75% will be taxed as income.

You can choose whether to take some or all that 75% out immediately, move it to drawdown so you can access it how and when you want, or use it to buy an annuity (a guaranteed income for life).

If you are doing a simple comparison between a general investment account and a SIPP, then it’s easy to see how you can conclude that 8.75% dividend tax is ‘better’ than 20% income tax and so you may want to move the shares outside the SIPP to take advantage of that lower tax rate.

However, it’s not a direct comparison, because of the other tax advantages that SIPPs offer.

The first difference is you will have received tax relief on your pension contributions when you paid them into the SIPP. This would have increased the amount of money in the pension pot by 20%, allowing you to buy a bigger share holding, so you have held more shares and therefore received more dividends.

A second difference is the tax treatment in the SIPP wrapper. Up to now the dividends paid out have remained within the SIPP wrapper (I am assuming you haven’t yet accessed your SIPP), and you haven’t paid any tax on dividends or capital gains, which may not have been the case if these had been held outside the tax wrapper and you had exceeded the tax-free dividend allowance of £500 or the capital gains tax-free allowance of £3,000.

Third, you are able to take 25% of your withdrawal from the SIPP as tax-free cash. This will bring the effective tax rate down from 20% to something closer to 15%. The income tax-free allowance – the personal allowance of £12,570 – should also be factored in.

And finally, if you did decide to withdraw the dividend stock holdings from the SIPP wrapper, you would initially have to sell the shares in the pension. You could then withdraw the sale proceeds from the SIPP and use them to buy the shares in a dealing account.

However, remember you may have to pay tax on part of that withdrawal (25% would be tax free) which would mean you would be able to buy back fewer shares.

You can take out as much money as you want from your pension, but a higher withdrawal may mean paying more tax and could even push you up into a higher tax bracket.

Comparing tax treatments through different accounts can be complicated, but it’s best to remember that pensions can be a very tax-efficient way of growing, and then taking, a retirement income.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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