- Income investors can generate a dividend yield of over 5% from five UK Equity Income investment trusts that have increased their dividend for 40 years on average
- These trusts could be delivering a yield of 8% in ten years’ time, based on historic dividend growth
- Holding £20,000 of these shares in an ISA could save a higher rate taxpayer £2,842 in dividend tax
- Dividend allowance is now just a tenth of its original size, with George Osborne introducing a trojan horse into the tax system in 2015
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“It’s not just cash savers and bond investors who are enjoying income yields above the rate of inflation, so are those buying investment trusts with exceptionally long records of increasing dividends. Five UK Equity Income trusts are currently yielding above 5%, together providing an average yield of 5.8%. That compares to the best variable Cash ISA yielding 5.11% and the best fixed term cash ISA yielding 5.25%, according to Moneyfacts.
“Of course, unlike cash, capital and income is not guaranteed when holding shares. However these trusts have increased their dividend each year for at least 23 years, through the dotcom crash, the global financial crisis, and the Covid pandemic. City of London investment trust has an unbroken dividend record stretching back to 1966, the year in which England won the football World Cup and number one records in the UK included songs from the Beatles, the Kinks and Elvis Presley.
“There’s no guarantee of a rising income going forward, but the resilience shown by these dividend heroes over such a long time should provide investors with some comfort. Investment trusts can hold back income in the bad years to pay out dividends in the good years, a mechanism which has allowed some to continually raise their dividends for decades. This doesn’t increase the overall dividend yield produced by the underlying portfolio of shares, but it does offer investors a smoother ride, something which is especially prized by those relying on their investment portfolio to deliver a retirement income.”
Source: Association of Investment Companies, data as at 8 March 2024
An 8% yield tomorrow from investing today
“Based on the historic dividend growth achieved by these trusts, after ten years they could be yielding 8% on an investment made today (based on a 5.8% current yield rising by 3.2% per annum). This also makes them an attractive segue for investors approaching retirement and looking to beef up their future income. Until the income taps are turned on investors can reinvest dividends, further bolstering their eventual income when they come to draw on it. These are of course not the only investment trusts available to investors, and others may offer a more appealing combination of income and growth prospects to some investors. However, these trusts do showcase the high income stream that can be generated by investing in UK stocks, alongside the prospects for a growing income stream too.
“The prospect for dividend and capital growth are key attractions provided by the stock market to income investors. This is in marked contrast to cash where over time the interest generated is dictated by interest rate changes in both directions, and where there is no long run upward trend that can be relied on. In the near term it looks like cash rates are likely to fall, with the market pricing in three interest rate cuts from the Bank of England this year. Further falls are then anticipated until the base rate reaches a stable level of around 3.25% in two years’ time (source: OBR). So while headline cash rates look appealing right now, those who are saving money for the longer term face a declining return picture in coming years.”
The ISA protection for income stocks
“As the tax burden rises as a result of frozen thresholds, so does the value of holding income-producing assets in an ISA. The dividend allowance is being cut to £500 from April, and 2.7 million people are forecast by the OBR to be brought into paying higher rate tax over the next five years, with a further 600,000 more taxpayers tipped into the additional rate tax bracket. The chancellor’s recent National Insurance cuts don’t alter this picture, and nor do they reduce the tax payable on dividends. A higher rate taxpayer investing £20,000 in a portfolio paying 5.8% with dividend growth of 3.2% per annum would save £2,842 over ten years by using an ISA. A higher rate taxpaying couple using their ISA allowance at the end of this tax year and the beginning of next, so £80,000 in total, would save £14,744.”
Source: AJ Bell, based on 5.8% portfolio yield with 3.2% annual dividend growth
George Osborne’s trojan horse
“Dividend taxation was reformed in 2015, in the summer Budget following the election, an ‘emergency’ fiscal event even though George Osborne continued to be chancellor after five years in the post. Higher rates of dividend taxation were brought in partly to reduce the incentives for small business owners to incorporate and thereby pay themselves dividends rather than an income on which National Insurance and income tax would be due. A dividend allowance of £5,000 was introduced alongside higher rates of dividend taxation to protect small shareholders, but that allowance has now been shredded to a tenth of its original size, to £500 from April 2024.
“George Osborne’s dividend tax reform proved to be a trojan horse future chancellors could sneak out of to ransack small shareholders by fiddling with the dividend allowance, rather than more visibly pushing up headline rates. Philip Hammond reduced the dividend allowance from £5,000 to £2,000 from April 2018. Rishi Sunak then increased dividend tax rates from April 2022, and Jeremy Hunt followed up with a cut to the dividend allowance to £1,000 this tax year and £500 next tax year. The result is a tax policy which initially provided a reasonable tax shield for small shareholders and which now affords the most modest of fig leaves instead.”
