How the Dividend Allowance and Personal Savings Allowance (PSA) work
The dividend allowance and personal savings allowance (PSA) can help reduce the amount of tax you pay on investment income, but they operate in different ways. This article explains how each allowance works, who can use them, and provides practical examples to show how they apply in real-life tax calculations. This is useful reading for your CII R03 or AF1 exam preparation.
This article is correct as at 3 July 2025 and is relevant to examinable tax years 2024/25 and 2025/26.
The dividend allowance and the PSA have been with us now since 2016. Since then, the amount of PSA has not changed but the dividend allowance has been reduced over time to where it sits now, just 10% of the original amount of £5,000. At a measly £500, the allowance is available to everyone regardless of tax status, whereas the amount of PSA does depend on tax status as follows:
| Income Tax Band | Amount of PSA |
|---|---|
| Basic-rate | £1,000 |
| Higher-rate | £500 |
| Additional-rate | £0 |
Let’s look at two examples of how the allowances work in practice; you should note that neither allowance extends the tax bands, they just exempt some of the income from being taxed.
Example 1
Jo is employed with gross earned income in the current tax year of £42,800. She also receives dividends from a share portfolio of £8,100.
Her total taxable income is £38,330, calculated as follows:
| Grossed earned income | £42,800 |
| Dividends | £8,100 |
| Total income | £50,900 |
| Less personal allowance | £12,570 |
| Taxable income | £38,330 |
- In CII calculations, the personal allowance is generally set against earned income
- £42,800 – £12,570 = £30,230
- Taxable income is charged at the appropriate rates for the band they fall into
- £500 of dividend income is covered by the dividend allowance and charged to tax at 0%
- £6,970 is taxed at 8.75% using up the basic-rate band (£37,700 – £30,230 – £500)
- The final £630 (£8,100 – £500 – £6,970) is charged at 33.75% as it falls in higher-rate tax.
| Earned income | £30,230 | @ 20% | £6,046.00 | |
| Dividend allowance | £500 | @ 0% | £0 | |
| Dividends at basic-rate | £6,970 | @ 8.75% | £609.87 | |
| Dividends at higher-rate | £630 | @ 33.75% | £212.62 | |
| Total Income Tax | £6,868.49 |
Example 2
Rishi is self-employed with profits in the current tax year of £43,600. He also receives interest from a savings account of £7,100.
His total taxable income is £38,130, calculated as follows:
| Profits | £43,600 |
| Interest | £7,100 |
| Total income | £50,700 |
| Less personal allowance | £12,570 |
| Taxable income | £38,130 |
- In CII calculations, the personal allowance is generally set against earned income
- £43,600 – £12,570 = £31,030
- Taxable income is charged at the appropriate rates for the band they fall into
- The first £500 of interest is covered by the PSA and charged to tax at 0%
- £6,170 is taxed at 20% using up the basic-rate band (£37,700 – £31,030 – £500)
- The final £430 (£7,100 – £500 – £6,170) is charged at 40% as it falls in higher-rate tax.
| Earned income | £31,030 | @ 20% | £6,206 | |
| PSA | £500 | @ 0% | £0 | |
| Interest at basic-rate | £6,170 | @ 20% | £1,234 | |
| Interest at higher-rate | £430 | @ 40% | £172 | |
| Total Income Tax | £7,612 |
As you can see, both the dividend allowance and the PSA count towards the basic-rate threshold but are charged at 0%.
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