- A dividend is a payment that any firm can make to shareholders in case it makes a profit.
- They are paid from the remaining share of a company profit after the essential expenses have been taken care of.
- They can be paid out by the company on a monthly, quarterly, half-yearly or yearly basis.
- The amount of tax paid on dividend depends on your income tax band. Shareholders have to pay Income Tax on their dividend income in case it is more than £2,000.
A dividend is a payment that any firm can make to shareholders in case it makes a profit. So, earning dividends can be a great incentive for investors, apart from a potential rise in share prices. In fact, through dividends, shareholders can earn money without trading shares.
Dividend payments reassure that they have good prospects of future earnings as the firm is profitable. They are paid from the remaining share of a company profit after the essential expenses have been taken care of. The rate of dividend is decided by the company’s board of directors, with approval of majority shareholders of the firm.
Let us now take a closer look at how the dividends work in the UK.
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How are they paid?
Dividends are paid based on the number of shares an investor owns in the company. They can be paid out by the company on a monthly, quarterly, half-yearly or yearly basis. For example, if you own 1000 shares in a firm and it announced a dividend of 100 pence, you are eligible to get £1000 as a dividend payment for that year.
Usually, a firm has to pay a dividend to all its shareholders. To pay the same, it has to declare the dividend payout in a directors’ meeting. Then it has to write a dividend voucher with the details of the shareholder, company name, date and dividend amount. A copy of the voucher needs to be given to the recipient of the dividend.
A dividend can generally be paid after the corporation tax has been calculated. But the company can’t classify it as a business cost.
Moreover, only a limited company (and not a sole trader) can issue a dividend payment.
Also, you need to note that not all profit-making companies choose to pay dividends. Some of them prefer to reinvest their profits into their businesses. In case you are interested in earning dividends, you must carefully select firms that offer them on a regular basis.
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Shareholders have to pay Income Tax on their dividend income in case it is more than £2,000, which is the annual dividend allowance in the UK at present. This allowance is available to all shareholders irrespective of their non-dividend income.
Further, some dividend income might be earned without paying any tax, in case it falls within your Personal Allowance (PA) limit. PA is the amount of income that you can receive every year without paying tax.
The amount of tax paid on dividend depends on your income tax band. While the basic-rate taxpayers pay a 7.5 per cent tax, higher-rate ones pay 32.5 per cent and finally, additional-rate taxpayers pay a 38.1 per cent tax rate on dividends.
Meanwhile, the company paying dividend does not have to pay any tax on these payments. To take advantage of this, many a time the company directors pay themselves a lower salary and a higher dividend to save on their overall tax liability.
Types of dividends
There are three main types of dividends – regular, special and preferred.
Regular dividends are mostly paid out in cash or stock out of a company’s profits to the shareholders. These dividends are paid out to common stockholders who get paid after the creditors, bond holders as well as preferred shareholders. Holders of common stock are generally not guaranteed a dividend payment, and it depends on the company’s choice to pay out the same in a given time frame or not.
Like regular dividends, special dividends are also paid on common stock but are paid out only if the company wishes to distribute accumulated profits after a number of years. It is usually larger than a regular dividend but is non-recurring in nature. It is often associated with a special event such as an asset sale.
Preferred dividends are issued to shareholders owning preferred stock. This stock has a fixed dividend value and acts more like a bond. This dividend gets a priority over the regular dividend. Some disadvantages of these dividends are interest rate sensitivity, dividend income risk, and lack of shareholder voting rights.
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Ways of dividend payment
Though usually paid out in cash, the other forms in which companies may choose to pay out the dividend are stock and property.
Cash dividend is the most common type of dividend used by companies. It can be paid out electronically or through a cheque.
A stock dividend is usually paid out in the form of shares instead of cash. They are usually paid out on a pro-rata basis.
In case of a property dividend, the company gives out property in lieu of a cash equivalent. However, this is a rare practice.