What is a Dividend? Tax and Yields Explained - NerdWallet UK (2024)

What is a dividend?

A dividend is a portion of company earnings distributed to some or all of its investors. If you own the right type of shares and the company you invested in is doing well financially, you might end up receiving these payments on a regular basis.

Why do companies pay dividends?

Companies generally share some of their profits with investors when they have enough cash left after expenses. This practice is fairly common, particularly among big, stable corporations that generate lots of money and have no need to reinvest proceeds back in the business.

Investors have countless options for where to park their money, and a healthy dividend can make the difference in attracting their capital to support or drive up share prices. In exchange, the shareholder collects a nice loyalty bonus that, when accumulated over several years, can boost their returns.

How dividends are paid

Dividends are distributed either regularly (typically twice a year) or on a one-off basis. In most cases, they are declared during the course of the fiscal year (the interim dividend) and at the end (the final dividend).

Occasionally, a company may announce a special dividend, too. These are one-off payments made to shareholders, usually after receiving a big windfall, say from the sale of an asset.

When a company’s board of directors agrees to pay a dividend, a set sum per share will be allocated. For example, a company in 2019 dished out £210.4p, payable in four quarterly tranches of 52.6p, netting an investor holding 10 shares an income payment of £2,104.

There are four important dates to take note of:

  • Declaration date: The day the board reveals its intention to pay a dividend.
  • Ex-dividend date: Investors must buy shares before this date to qualify for the upcoming dividend.
  • Record date: This is the date the company uses to determine which shareholders are invested and thus entitled to the dividend.
  • Payment date: The dividend is dispensed and appears in the investors account. This is around one month after the record date.

What is a dividend yield?

The dividend yield expresses the size of the dividend relative to the share price. It is a financial ratio of dividend/price.

If a company whose shares cost 200p, or £2, each distributes payments of 10p, its yield is 5%: 10/200×100=5.

Dividend yields are closely monitored as they essentially tell how much cash you’ll get back for each pound invested in a particular holding. They should be treated with caution, though. The higher the yield, the bigger the reward – and risk of being left empty-handed.

Not all companies are prudent. Some live beyond their means, offering generous dividends, subsidised by borrowing money or offloading assets, to keep investors sweet they may paper over the cracks of an otherwise unappealing investment.

It’s also worth bearing in mind that yields rise when share prices fall: a sign of an adverse change in fortunes that could impact the company’s ability to maintain payouts.

Is dividend investing safe?

Like any stock market-based investment, income on shares isn’t guaranteed. Companies aren’t obligated to deliver dividends, and in times of trouble they may have little choice but to slash or completely axe these non-essential business expenses.

No board wants to do this. Taking such action implies that finances are worsening and almost always leads numerous investors to jump ship. Sometimes, however, there’s no alternative.

Because of these risks, investors are advised to do their homework. Make sure the company has a history of generating plenty of excess cash, a favourable outlook to continue doing so, and is not shackled with debt or other forthcoming expenses that may impact its ability to keep up with payments.

Track records should be scrutinised as well to identify who honours commitments and was able to maintain and even grow dividends during a rough patch.

How to determine if a dividend is sustainable

Investors have several tools at their disposal to examine the robustness of a dividend. One simple, frequently used method is to divide a company’s earnings per share (EPS) by its dividend per share (DPS).

The dividend coverage ratio measures how many times the company can afford to pay its dividend from the profits it’s making. Usually, anything below 1.5 should set off alarm bells, unless there’s a reasonable explanation or the subject fits the mature, defensive company profile.

Another popular technique is the payout ratio. This metric works in the opposite way, dividing DPS by EPS to reveal the percentage of earnings dispensed to investors.

Low payout ratios, like high dividend coverage ratios, imply the subject can comfortably fund dividends, leaving it with enough money to cover any emergencies or setbacks, and strengthen its operations to the long-term benefit of shareholders.

Not all businesses are the same, though. Some are able to shell out large chunks of profits without endangering their prospects. Others can’t afford this luxury and will be expected to allocate a much smaller percentage or nothing at all to dividends.

Should I reinvest dividends?

When investing in funds and shares, it’s possible to automatically reinvest any income you receive back into the investment that distributed it.

Many swear by this strategy, arguing it represents one of the best ways to grow wealth. But it isn’t flawless and might not be suited to everyone. Speak to a financial adviser if you’re unsure of the investment strategy that could be right for you.

Do you pay tax on dividends?

Earn more than £2,000 from dividends in a year and you may need to inform HM Revenue and Customs. Payments in excess of this amount are taxed in the following way:

Income tax band*Dividend Tax rate
Basic rate (income between £12,501 and £50,000)7.5% dividend tax rate
Higher rate (income between £50,001 and £150,000)32.5% dividend tax rate
Additional rate (income above £150,000)38.1% dividend tax rate

Source: UK Government
*Income tax bands differ slightly for people living in Scotland

The good news is you also have access to an annual £20,000 tax cushion before these rates apply, courtesy of stocks and shares ISA. Invest via one of these accounts and you can keep every penny you make.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you.

Image source: Getty Images

About the Author

Daniel Liberto

Daniel is a freelance finance journalist. He has written and edited news, deeper analysis features, and opinion pieces for the Financial Times, Investopedia and the Investors Chronicle.

Read More

Dive even deeper

Investing for Beginners: What is a Brokerage Account?

While investing can seem very complex, opening a brokerage account and starting to invest is surprisingly easy. You can either place your own trades through an online account, or hand control over to a financial adviser and investment manager. Discover how to open a brokerage account below.

Connor Campbell

Investing: what is an index?

An index, such as the FTSE 100 or Dow Jones, is a selection of financial assets structured to track the price performance of a specific segment of the stock market. Read on to find out more about how indices work, what they are used for, and how you can invest in them.

Connor Campbell

Investing: what is an index fund?

Index funds turn indices, which have no physical value, into something you can invest in by mirroring their contents. The two main types of index funds are index mutual funds and index ETFs. To find out more about how you can invest in index funds, read on.

Connor Campbell

I'm a financial expert with a deep understanding of investment concepts, particularly in the realm of dividends and dividend investing. My expertise is rooted in practical experience and a thorough knowledge of financial markets.

Now, let's delve into the concepts discussed in the article you provided:

What is a Dividend?

A dividend is a share of a company's earnings distributed to its investors. Investors receive these payments if they own the right type of shares and the company is financially sound.

Why Do Companies Pay Dividends?

Companies pay dividends when they have excess cash after expenses. This is common among stable corporations that generate significant profits and don't need to reinvest all proceeds back into the business. Dividends attract investors and can positively impact share prices.

How Dividends Are Paid

Dividends are distributed regularly or on a one-off basis, typically declared during the fiscal year. There are four crucial dates to note: Declaration date, Ex-dividend date, Record date, and Payment date.

What is a Dividend Yield?

Dividend yield is the ratio of dividend to share price, expressed as a percentage. It indicates how much cash an investor gets back for each pound invested. High yields come with both rewards and risks, and caution is advised.

Is Dividend Investing Safe?

Dividend income isn't guaranteed, and companies may cut or eliminate dividends in tough times. Investors need to do thorough research, considering a company's cash generation, outlook, and track record in maintaining dividends during challenges.

How to Determine if a Dividend is Sustainable

Investors use tools like the dividend coverage ratio and payout ratio. A ratio below 1.5 could raise concerns, while low payout ratios imply a company can comfortably fund dividends and strengthen its operations.

Should I Reinvest Dividends?

Reinvesting dividends can be a strategy to grow wealth, but it may not suit everyone. Consult a financial adviser to determine the right investment strategy for you.

Do You Pay Tax on Dividends?

Dividend income above £2,000 in a year may be taxed. The tax rates vary based on income tax bands, and there's a £20,000 tax cushion with stocks and shares ISAs.

This overview provides a comprehensive understanding of dividends and essential considerations for investors. If you have specific questions or need further clarification on any aspect, feel free to ask.

What is a Dividend? Tax and Yields Explained - NerdWallet UK (2024)


How does dividend yield work UK? ›

What is a dividend yield? The dividend yield expresses the size of the dividend relative to the share price as a percentage. It is usually calculated by dividing all dividend payments from a 12-month period by a company's share price.

What is the dividend tax in the UK? ›

Working out tax on dividends
Tax bandTax rate on dividends over the allowance
Basic rate8.75%
Higher rate33.75%
Additional rate39.35%

What is the difference between a dividend and a dividend yield? ›

While dividend yield refers to the percentage of the current stock price of a company paid out as dividend over a year, dividend rate is the amount of money that company pays to its shareholders as dividends on per-share basis.

What does 7% dividend yield mean? ›

Dividend yield is a ratio that shows you how much income you earn in dividend payouts per year for every dollar invested in a stock, a mutual fund or an exchange-traded fund (ETF). To put it another way, dividend yield is a security's annual dividend payment expressed as a percentage of its current price.

What is a dividend yield for dummies? ›

Dividend yield is a stock's annual dividend payments to shareholders expressed as a percentage of the stock's current price. This number tells you what you can expect in future income from a stock based on the price you could buy it for today, assuming the dividend remains unchanged.

Is it better to take dividends or salary UK? ›

The short answer for business owners is that for basic rate taxpayers, paying dividends is nearly always the better option, regardless of changes in the Corporation Tax (CT) rate the company pays. This is because dividends do not attract NICs and offer tax advantages for lower rate taxpayers.

Do US citizens pay tax on UK dividends? ›

How are dividends in the UK generally taxed by the IRS? Because the UK has a Tax Treaty with the US, UK dividends are subject to preferential tax rates instead of the regular tax rate of up to 39.6%. These UK 'qualified dividends' are only subject to 0-20% tax.

Do foreigners pay dividend tax in UK? ›

Individuals who are non resident in the UK are not taxable in the UK on UK interest or dividends received. However, if tax is deducted at source from the interest and/ or dividends, then some or all of the tax may not be refundable ( this is known as disregarded income).

How much dividend is tax-free in UK? ›

Understanding the annual tax-free UK Dividend Allowance

You can earn up to £1,000 for the 2023/24 tax year and £500 for 2024/25, before you pay any Income Tax on your dividends, this figure is over and above your Personal Tax-Free Allowance of £12,570 in the 2023/24 and 2024/25 tax years.

Is dividend yield the same as interest rate? ›

Comparing Yield and Interest Rate:

Yield represents the total earnings from an investment, including interest. Interest rate is the percentage of the amount borrowed or paid, over a principal amount. Yield typically includes the amount of interest earned. Interest is calculated independently of yield.

How is dividend yield paid out? ›

Dividends, a distribution of a portion of a company's earnings, are generally paid in cash every quarter to shareholders. The dividend yield is the annual dividend per share divided by the share price, expressed as a percentage; it will fluctuate with the price of the stock.

Is dividend yield the same as return? ›

Total return, often referred to as "return," is a very straightforward representation of how much an investment has made for the shareholder. While the dividend yield only takes into account actual cash dividends, total return accounts for interest, dividends, and increases in share price, among other capital gains.

Which is better dividend or yield? ›

Both metrics are important for equities investors. While the dividend rate indicates total expected income, the dividend yield provides more information on the rate of return and can be useful in comparing different income-paying assets. Apple, Investor Relations.

Is 10 dividend yield too high? ›

Generally speaking, double-digit dividend yields are indeed too good to be true. They are often either being paid by unstable companies, or simply represent too much of a company's earnings to be sustainable. Of course, there are some exceptions.

What is more important dividend rate or yield? ›

While the dividend rate shows the absolute amount of dividend paid per share, the dividend yield factors in the stock's current price, offering a more insightful measure of the return on investment.

What does 5% dividend yield mean? ›

The dividend yield is a financial ratio that tells you the percentage of a company's share price that it pays out in dividends each year. For example, if a company has a $20 share price and pays a dividend of $1 per year, its dividend yield would be 5%.

What does a 3% dividend yield mean? ›

For example, if a company has an annual dividend of $3 per share and is currently trading at a stock price of $100, then its dividend yield is 3%.

Is a 3% dividend yield good? ›

Dividend yield is a percentage figure calculated by dividing the total annual dividend payments, per share, by the current share price of the stock. From 2% to 6% is considered a good dividend yield, but a number of factors can influence whether a higher or lower payout suggests a stock is a good investment.


Top Articles
Latest Posts
Article information

Author: Rueben Jacobs

Last Updated:

Views: 5324

Rating: 4.7 / 5 (57 voted)

Reviews: 88% of readers found this page helpful

Author information

Name: Rueben Jacobs

Birthday: 1999-03-14

Address: 951 Caterina Walk, Schambergerside, CA 67667-0896

Phone: +6881806848632

Job: Internal Education Planner

Hobby: Candle making, Cabaret, Poi, Gambling, Rock climbing, Wood carving, Computer programming

Introduction: My name is Rueben Jacobs, I am a cooperative, beautiful, kind, comfortable, glamorous, open, magnificent person who loves writing and wants to share my knowledge and understanding with you.