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22 February 2019

With companies around the world now paying out record level dividends, David Prosser examines a crucial advantage investment companies have when it comes to delivering income.

Some good news for income seekers at last – at least those who are prepared to embrace stock market investment as a way of capturing income. Companies around the world are now paying out record levels of dividends, rewarding shareholders with bumper pay-outs despite fears about global economic growth and headwinds such as Brexit.

Data from Janus Henderson reveals that global companies paid out $1.37 trillion in dividends during 2018, more than ever before – and almost 10 per cent up on 2017. More than a third of that income came from US companies, with American businesses making higher dividend payments in response to tax reforms. Japan, Europe, Asia-Pacific and several emerging markets also had a record year.

The UK is performing strongly too, with dividends up by almost 9 per cent at an underlying level during 2018, excluding the effect of one-off payments such as special dividends. As a result, the typical UK company now trades at its highest yield for more than a decade.

For investors battered by an extended run of ultra-low interest rates, this buoyant period for dividends offers some welcome respite. That’s not to suggest setting stock market yields against the rates available on cash is a fair comparison, but for those investors prepared to commit to equities – and the risk of capital loss - the income on offer is now highly attractive.

So how do investors go about securing that income? Well, the first point to make here is that what many investors want as much as an improved yield is consistency of income. If you’re dependent on investment income – as part of a pension drawdown arrangement, perhaps – dividend volatility is difficult to plan for.

In that regard, an investment company offers a crucial advantage. The unique ability of investment companies to maintain reserve funds, holding back some income in stronger years for dividend receipts in order to top-up pay-outs in less bountiful periods, is hugely important. It’s why there are more than 20 closed-ended funds that have been able to raise dividends in each of the past 20 years (including four that have raised pay-outs every year for 50 years or more).

The second issue to consider here is tax efficiency. The dividend allowance – the total amount of dividends investors may earn before paying income tax – was reduced from £5,000 to £2,000 with effect from last April. At current yields, that means the average UK stock market investment will expose its owner to income tax once it reaches £46,500 or so, compared to around £135,000 previously. That still only affects a minority of investors, but a bigger minority than previously.

Large investment company portfolios constructed to generate income are often to be found in people’s pensions, where income is not taxable. But if not, it will be important to make the best possible use of individual savings accounts (Isas), where income can also be sheltered from tax. And even those investors not yet close to paying tax need to take care – by the time their portfolios grow to a level where tax does become an issue, it may be difficult to tackle the problem.

As the tax year draws to a close – and time runs out to use another year’s £20,000 Isa allowance – this should be a consideration for many investors and their advisers. Investment company sectors including UK Equity Income and Global Equity Income feature attractive high-yielding funds offering the promise of consistent levels of income – but keep tax efficiency in mind too as you think about how to buy and hold these funds. Inside an Isa or a pension will be the ideal for many.

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