How Much Tax Do You Pay on Index Funds in the UK?

Index funds and ETFs that allow investors to passively track the stock market, or specific parts of the stock market, have surged in popularity across the UK.

Recent figures from Hargreaves Lansdown reveal they now represent more than 10% of client investments.

But there’s an important elephant in the room that needs to be addressed: tax.

What you’ll owe in tax to HMRC often depends on how you’re making an investment — and the nature of any gains made.

In some cases, you won’t need to pay any tax at all.

Tax-efficient investing

Every single Brit can invest up to £20,000 a year into a Stocks & Shares ISA without having to pay Capital Gains Tax or dividends taxes on your profits.

100% of the profits made from stocks and shares in ISAs is yours to keep for life — no tax on profits. And for clarification, ETFs and index funds are included in this.

Similar is true for self-investment personal pensions, more commonly known as SIPPs.

Whilst the tax-free pension withdrawal limit is capped to £268,725 in retirement, you can actually get tax relief with a SIPP when investing in index funds, ETFs, stocks, shares or other commodities.

This is the opposite of paying tax — the government pays tax back to you.

You’ll get 20p back for every £1 you put in if you’re a basic-rate taxpayer — and if you’re on a higher or additional rate, a further 20p or 25p can be claimed through a self-assessment tax return. We’ve got a full explainer on how this works here.

But if you’re not investing inside a tax-efficient account, HMRC will come knocking.

There are three main types of tax liability to be aware of: Capital Gains Tax, income tax on dividends, and stamp duty reserve tax.

And on top of that, there are some other small taxes that will apply when investing in index funds.

Understanding Capital Gains Tax

Capital Gains Tax (CGT) is quite a money spinner for the government. Official estimates suggest it’ll raise £15.2 billion in 2024/25 — that’s worth about £530 per household.

As the name suggests, CGT is a tax on any gains you make by selling an investment.

Let’s imagine that you invest £20,000 across several funds — not inside a tax efficient account — and later sell up when the balance is £35,000. CGT would be due on that profit of £15,000.

Up until recently, Brits had a pretty generous tax-free allowance on capital gains, meaning they could earn £12,300 before paying a penny to the taxman. But this has now been slashed quite dramatically — all the way down to £3,000 in 2024/25.

In our scenario above, after the £3,000 tax limit is taken into account, £12,000 would be subject to CGT.

What you’ll pay in CGT depends on which income tax bracket you’re in. It’s 10% for basic-rate taxpayers, rising to 20% for higher and additional rate taxpayers.

You’ll need to declare these gains on a self-assessment tax return — and it might be worth enlisting the help of an accountant or financial adviser, who can offer advice on how to legally reduce this bill.

For example, transferring assets to your spouse or civil partner means you’ll collectively have a tax-free allowance of £6,000. And if you’ve made losses from other investments in the past four years, they can be deducted from more recent realised gains too.

Income tax on dividends

One of your investment goals might be to receive regular dividends from the index funds you invest in.

If returns from dividends exceed a certain threshold, it’ll be treated as income. That leads to tax.

Annual dividend allowances have also been lowered substantially of late — from £5,000 back in 2016/17 to just £500 in 2024/25.

Any annual earnings beyond this level will be taxed at 8.75% if you’re a basic rate taxpayer, 33.75% if you’re on a higher rate, and 39.35% at an additional rate.

This can be settled either by contacting HMRC and requesting a tax code change so it’s deducted from your salary or pension — or by filling out a self-assessment tax return.

You don’t need to inform HMRC if your dividends come in below this £500 level.

Stamp duty

Buying individual shares in UK companies results in Stamp Duty Reserve Tax (SDRT) that’s equivalent to 0.5% of the transaction’s value. This would be £5 on a £1,000 investment into shares.

Online trading platforms factor this in automatically and pay it to HMRC on your behalf.

You won’t pay stamp duty if you’re investing in index funds and ETFs.

However, the issuer will need to pay this tax when purchasing UK shares to include in a portfolio. This may be passed on to you indirectly in the form of slightly higher management fees.

Smaller taxes to be aware of

Certain other taxes only apply in very specific circumstances.

For example, a £1 charge known as the PTM levy applies if you’re selling British shares worth more than £10,000. This finances the Panel of Takeovers and Mergers, a regulator that aims to ensure the interests of all shareholders are protected if a company is being acquired. However, the PTM levy doesn’t apply to index funds or ETFs.

If you’ve gained exposure to global index funds consisting of French firms with a market cap of over €1 billion — such as Air France, Danone or EDF — fees might end up being a little higher because of the French Financial Transaction Tax. That’s because issuers will need to pay a 0.3% charge when adding shares to portfolios.

Over in the US, FINRA fees of $0.000166 per share and SEC fees of 0.0008% of a transaction’s value also apply whenever index funds are being sold. These are rounded up to the nearest penny, so the minimum you’ll pay is $0.01 — and there’s a cap for larger transactions of $8.30. Generally speaking, you shouldn’t lose too much sleep over this — the fees are extremely small and are taken automatically by whichever broker you’re using.

Finally, withholding taxes may kick in if you’re a UK investor who receives dividends from funds that are based abroad. As an example, payouts from a US-based issuer may see 30% deducted from your payouts, falling to 15% if you fill out a W8-BEN form through your chosen trading platform.

Inheritance tax

It’s also important to consider the potential tax implications when you pass away.

The first £325,000 of your estate is not subject to inheritance tax — but beyond this threshold, a rate of 40% applies.

This would also apply to any investments you hold, including index funds.

Although profits in ISAs are completely tax-free while you are alive, they are not exempt from inheritance tax when you pass away.

What’s owed will be based on how much an index fund was worth when trading closed on the day of death.

Investments in shares (including index funds and ETFs) can be gifted to members of your family — and no inheritance tax will be owed as long as seven years pass before you die. It’s worth getting professional advice before completing such a transaction, as there will likely be Capital Gains Tax to consider.

If you’re married or in a civil partnership, your spouse can inherit your entire estate, including your index funds, with no inheritance tax to pay.

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