There's a reason stocks and shares ISA investors have fallen in love with dividends and dividend income since the financial crisis in 2008.
Record low interest rates imposed right after the stock market crash and huge central bank bond-buying schemes nailed bond yields to the floor. If you were a bond investor or had some fixed income in your ISA, that meant your income stream dried up.
Cash ISA savers got an equally raw deal.
Broadening their search for passive income from investments, a lot of would-be bondholders and cash savers climbed the risk ladder into equity income funds (baskets of equities with dividends, run by a fund manager) and dividend-paying stocks.
The big targets among direct equities and mutual funds were huge consumer staples firms with sprawling global reaches, fairly predictable revenue streams and, crucially, progressive dividend policies.
Read more:
What are dividend stocks and how do dividends work?
Five (and a half) tips to boost your dividend income
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The search for yield: from bonds to equity income
Such was the shift from bonds into big dividend stocks like Unilever and Procter & Gamble that we forgot all about fixed income for over a decade.
But the pandemic showed us we got a bit complacent around these so-called bond proxies. Fears over what Covid could do to the global economy scared the life out of a lot of these dependable dividend payers.
And when sectors like banking tightened the purse strings, dividend payouts in the UK and US fell off a cliff. Mutual funds and individual stocks with reputations for dividend income really felt the heat.
That quick history lesson brings us to today, against a backdrop of recovering economies, higher inflation, rising interest rates and dividends from individual securities pretty much back online across the board.
It's a good time to revisit the role ISA dividends play and how we can find the best dividend stocks out there, as well as maintain a sensible attitude to investing for income.
If we just go headlong into the highest dividend paying stocks in the UK and US without looking at how they're set up to maintain those income payments, we really won't have learnt anything from the past few years.
Stocks and shares ISAs and dividends: the lowdown
One of the draws of using a stocks and shares ISA to invest in dividend stocks comes down to the tax efficiencies on offer. But there’s a lot more to ISAs than income. Here’s your rundown on the benefits of ISAs including those tax benefits and a whole lot more.
You can read more about them in our ‘What is a stocks and shares ISA?’ article.
Stocks and shares ISA benefits
An individual savings account (ISA) is a tax-efficient way to save and invest, as you don’t have to pay UK tax on any gains you make. Any money you earn from your investments in a stocks and shares ISA won’t attract:
- Income tax on dividends or interest
- Capital gains tax, if you sell your investments for a profit
With a stocks and shares ISA some of the assets you can invest in are:
- Stocks
- Exchange-traded funds (ETFs)
- Investment trusts (also called investment companies)
- US real estate investment trusts (REITs)
- Special purpose acquisition vehicles (SPACs)
Each tax year HMRC sets an ISA allowance. You can put up to £20,000 into your ISA over the 2024/25 tax year (which ends on 5 April 2025) and you'll get a new allowance from 6 April 2025 for the 2025/26 tax year.
Before diving in, it's important to understand that any tax treatment depends on your individual circumstances and may be subject to change in future. If tax makes you uneasy it might even be worth chatting to a tax specialist or financial planner for advice too.
You also need to be comfortable with the fact that the value of your investments and any income they offer can fall as well as rise (2020 is evidence enough of that), so you might get back less than you originally invested.
Stocks and shares ISA dividends
Using a stocks and shares ISA for dividend-paying stocks can make sense when you understand the tax you’d have paid on your dividend income had you not used a tax-efficient account.
UK tax on dividends
In general, UK investors using non-ISA accounts can earn £500 in dividend income during the current tax year (6 April 2024 to 5 April 2025) without paying tax on it.
Once your dividend income goes above this so-called dividend allowance, how much tax you pay depends on the income tax band you fall into.
Basic rate taxpayers pay 8.75% tax on dividend income over the £500 allowance. Higher rate taxpayers pay 33.75% and additional rate taxpayers pay 39.35%.
Read more:
Building a dividend portfolio for 2022
Three dividend stocks you’ve never heard of
Five alternative income sources for dividend investors
Given that we should be looking to the long term and giving our investments as much time as possible to compound, those dividends could seriously swell above your personal allowance.
The benefit of using an ISA for dividend investing might not be immediately obvious but not making the most of the account's tax efficiencies now could hurt later down the line.
The last thing you want to be doing in 20 years is Googling some variation of “Is there a way to avoid taxes on dividend-paying stocks?” and finding out all it took was kicking off an ISA two decades earlier.
That's especially important if you're trying to use your ISA dividend income to pay the bills between giving up work or reducing your hours in the years before you can access your pension.
Every penny counts and stumping up tax payments when you could have set yourself up to be much more tax-efficient instead could be very annoying.
On a practical note, a lot of investors get peace of mind from stocks and shares ISAs purely from having to do less investment admin. Tax forms, tax rules and mental maths around your personal savings allowance and dividend amounts can be a real headache.
Can you get dividends in a stocks and shares ISA?
As we've said, an ISA can be a great account in which to generate dividend income and investment growth from your investments tax-efficiently.
We say ‘tax-efficient' because there are quirks that investors forget about sometimes, normally when we talk about dividend tax on US stocks.
The default withholding tax rate on US shares is 30% but that rate can fall to 15% for UK residents who fill in a W-8BEN form.
And there's an added bonus for pension investors. That same double tax agreement between the UK and US that brings the 30% withholding tax down to 15% for UK investors can extend that to 0% for self-invested personal pensions (SIPPs).
Yet another reason to consider using a tax-efficient account like a SIPP to buy US stocks.
What happens with dividends in a stocks and shares ISA account?
If you've invested in dividend-paying companies in your stocks and shares ISA, once there is a distribution of dividends and the income is paid, you'll see it land in your ISA.
You don't have to even think about any UK dividend income tax or capital gains tax, you can just keep on investing - after all, that's one of the advantages of an ISA.
Should you reinvest dividends or withdraw them?
It's up to you what you do with those corporate dividends once you receive them.
Don't get caught up in the excitement of a payment hitting your ISA though, instead focus on your long-term goals.
If you're firmly in the accumulating phase of your journey, think about reinvesting dividends from a variety of securities. It's the very basis of compounding (that mathematical snowball effect we all learnt about at school) and putting those payments back into your dividend-generating assets gives them a good chance of giving you an even bigger dividend next time.
Going back to 1970, reinvested dividends and the power of compounding have attributed 84% of the total return of the US S&P 500 index, according to Hartford Funds.
The investment firm says an initial £10,000 invested in the S&P 500 over the 60 years from 1960 to 2020 would have grown to $627,161 in price terms, or $3,845,730 with dividends reinvested.
Dividends are incredibly important to the value of total returns so whether you choose an accumulation share class of an ETF to do the work for you, or you have your own regular dividend reinvestment program, don't leave income idle on the sidelines.
It's important to say though, dividend stocks aren't guaranteed to outperform their income-free cousins in a declining, flat, or rising market.
Past performance is not a reliable indicator of future returns.
Total annual return
Source: ycharts.com, as at 17 April 2024. The Total Return is the investment return received each year including dividends.
If you're on the other side of the accumulation path, and have started to use your investments to supplement another income, withdrawing ISA dividends comes with the benefit of attracting no tax.
You won't build up that compound effect anymore but chances are, if you're in this stage, you'll have done that for a while in preparation for actually using your money.
Read more: How are dividends paid on Freetrade?
Do reinvested dividends count as ISA contributions?
No. As dividends from stocks in your stocks and shares ISA don't leave your tax wrapper, they won't count as a contribution towards your £20,000 annual ISA allowance.
That's true whether you have an asset which automatically reinvests those dividends (like the accumulation share class of an ETF) or they land in your account as cash and you then reinvest them yourself.
Do you pay tax on dividends in an ISA?
As we've said, it's better to say ISA dividends are tax-efficient rather than tax-free because of how US withholding tax can come into the equation.
For UK investors holding UK stocks in their ISA though, that question is often a way of asking if they'll pay income tax on those dividends. The short answer here is no, they don't have to.
ISA investors get to keep all the gains they make from assets in their ISA account without having to think about paying capital gains tax or income tax on any dividends.
Do I declare ISA dividends on my tax return?
No. You don't have to declare ISA dividends on your annual tax return.
It's a common question though, and we can see why people dread asking it. Tax is one headache, paperwork is another. Put them together and ‘tax paperwork' just seems cruel.
The good thing is using a stocks and shares ISA for dividend investing gets rid of the need to worry about either of those grimace-inducing words.
Think about all that extra time you'll get back and what you'll do with it. The possibilities are endless.
Dividends stocks for your ISA account
2020 was a tough year for UK dividends. Most big income-payers took a deep breath and either reduced payouts or cut dividends altogether.
The feeling was that protecting cash reserves was more important than paying out at a time when there was so much uncertainty around the pandemic and global economies.
The regulator even asked the UK's banks to kindly stop paying dividends until the worst of the pandemic was behind us.
Thankfully, 2021 ended in a much more promising position, with the banks being given the thumbs up and UK dividend payments leaping by 46.1% to £94.1bn according a 2022 Dividend Monitor report from Link Group.
The result is that the total amount paid out in UK dividends got back to the same level it was in 2017. Helping boost that number was £16.9bn in special dividends across various sectors, as companies assessed the Covid damage and breathed a sigh of relief that they didn't actually need all that cash in the end.
What this means is that we're pretty much back to normal on the dividend front (touch wood) and, while companies are very much still dealing with Covid-related struggles, they're broadly past the point of raiding the dividend purse.
A big takeaway for dividend hunters amid all of this has been how important it is to focus on the consistency of income payments in their portfolios. If you were relying on bank stocks for your income, 2020 would have been a very difficult year indeed.
We can never be completely sure of steady and rising dividends - investing is an unpredictable venture - but there are corners of the market with a greater focus on maintaining dividend consistency than most.
Investment trusts for income: the dividend heroes
One of the characteristics of investment trusts that income seekers tend to like is their ability to squirrel away up to 15% of their income each year, so they can boost payouts when dividends are harder to come by.
That was particularly useful in 2020's dividend drought. During the year 91% of trusts in the UK equity income sector either increased or maintained their dividends, according to the Association of Investment Companies (AIC).
The trusts with long track records of increasing their dividends can make it onto the coveted dividend hero list if they rack up at least 20 years of consistent rises. Granted, that's all backward-looking but it's a sign of a commitment to preparing for the worst.
You'll find the current list below but it's important to highlight that this is not a suggestion or recommendation that you buy or sell any of the securities mentioned.
Remember that everyone has their own goals and unique financial circumstances. These, along with your tolerance for investment risk and time horizon, should inform the mix of assets in your portfolio.
Our resource hub for investing in the stock market might be able to help make that blend a bit clearer for you and our guide on how to invest in stocks is a great start for first-time investors. And if you are still unsure of how to pick investments, speak to a qualified financial advisor.
UK investment trusts for income: the 2024 UK 100 dividend heroes
AIC dividend heroes
Source: AIC as at 17 April 2024.
UK stocks for income: the 2024 UK 100 dividend aristocrats
On the company front (we know investment trusts like to be called investment companies these days but we just gave them their own section) the UK dividend aristocrats are a select group of firms who have kept a dividend growing for at least 20 years.
Again, none of this is intended as a prompt to rush out and buy or sell shares in any of the companies mentioned, and some of those dividends will be small despite their consistency.
Dividend aristocrats
Source: Dividenddata, as at 17 April 2024.
Be careful of dividend clumping
So, we've seen it's more sensible to look for consistent yielders than flash-in-the-pan high yield stocks. But it's not just a case of snapping up anything connected to these types of companies.
The most popular mutual funds in the Investment Association's (IA) equity income sector look incredibly similar to each other.
If you buy a few UK equity income funds without peering under the bonnet, chances are you're doubling or tripling up on the same companies.
Bizarrely, this can mean that while you think you're diversifying, you're actually concentrating your money in just a few companies.
Keep it simple, keep it diverse, and keep an eye on exactly what you hold and why.
How to invest in ISA dividend stocks
Once you’ve considered the investment risks and weighed them up against the potential benefits of investing, here’s a straightforward step-by-step guide explaining how to invest for dividend income:
- Compare brokerage accounts to decide which one best suits your investing platform needs. Compare our plans to see which one could be right for you.
- Open a stocks and shares general investment account (GIA) with your broker of choice. You might want to factor in tax efficiencies here. Think about whether a GIA, stocks and shares ISA or self-invested personal pension (SIPP) could help. Once you’ve decided, make your first deposit.
- Research the type of company you want to invest in. Remember not to get hypnotised by one-off dividend hikes or an enormous dividend yield. It's much more important to look at the sustainability of a firm's dividend policy. So, have a look at previous and upcoming dividends, interim dividends and, why not, annual dividends too. If you'd rather not keep on top of all the company news, equity funds with a fund manager at the helm might be worth exploring, or an equity tracker fund focused on dividend payments.
- Make sure the stock fits in with your overall investment strategy in a diversified portfolio, and that the rest of your finances are in a healthy position. 2020 showed us it's useful to diversify your income sources, so remember to at least consider REITs (for rental income), bonds (for fixed income) and basically every type of investment with an income stream.
- Select how much you would like to invest. Think about your portfolio and how you want to balance it between different positions, how much you can invest, and the frequency of investments to help figure out how big or small a holding you want.
For some more guidance, you can read our in-depth guide on how to invest in stocks.
As an investor, it’s extremely difficult to consistently pick investments that will succeed no matter what's happening in the world. So, rather than getting bogged down in short-term dividend per share analysis, keep the broader horizon in mind. If a firm has a clear commitment to paying dividends, that should help its annual compound return over time, even if the company shares have an off year.
We’ve created one of the UK’s leading stock trading apps to help everyone build their wealth over the long term. Join over 1 million users that have chosen Freetrade for their general investment account, stocks and shares ISA and/or self-invested personal pension (SIPP).
Important information on SIPPs
ISA eligibility rules apply. Tax treatment depends on personal circumstances and current rules may change.
A SIPP is a pension designed for you to save until your retirement and is for people who want to make their own investment decisions. You can normally only draw your pension from age 55 (57 from 2028), except in special circumstances.
At present, Freetrade only supports Uncrystallised Fund Pension Lump Sums (UFPLS) for customers who wish to withdraw funds from their SIPP after their 55th birthday. We strongly encourage you to seek financial advice before making any withdrawals from your SIPP.
