What are dividends and how do they work?

What is a dividend?

A dividend is a portion of a company's profits distributed to shareholders as a reward for owning its shares. Not all companies pay dividends. Growth-focused businesses, particularly in technology, often reinvest all available profits back into the business rather than returning cash to shareholders. Dividend payments are more common among large, established companies in sectors such as banking, insurance, utilities, consumer goods and energy, many of which are well represented in the FTSE 100.

Dividends are typically paid in cash, either quarterly or twice a year. Some companies also issue stock dividends, where shareholders receive additional shares rather than cash. Occasionally, companies pay special dividends, which are one-off distributions on top of the regular dividend, often following an asset sale or period of particularly strong profitability.

How do dividends work?

When a company decides to pay a dividend, the board of directors proposes the amount and the payment is subject to shareholder approval. There are several key dates involved in the process:

The ex-dividend date is the most important for investors to understand. If you buy shares on or after this date, the previous owner receives the dividend, not you. Share prices often dip by approximately the dividend amount on the ex-dividend date, though other market factors can obscure this movement.

Dividends by the numbers

£88bn FTSE 100 companies forecast to pay in dividends in 2026, a projected record high (indieinvestor)

3.1% Current FTSE 100 trailing dividend yield (Dividend Data)

£500 UK dividend allowance for 2026/27: the amount you can receive tax-free before dividend tax applies (ISAs exempt)

What is dividend yield?

Dividend yield is a measure of how much income a share generates relative to its price. It expresses the annual dividend as a percentage of the current share price, allowing investors to compare the income generated by different shares and asset classes on a like-for-like basis.

Dividend yield = (Annual dividend per share ÷ Share price) × 100

For example, if a company pays an annual dividend of 50p per share and its share price is £10.00, the dividend yield is 5%. If the share price rises to £12.50 while the dividend stays the same, the yield falls to 4%. If the share price falls to £8.00, the yield rises to 6.25%. This inverse relationship is important: a rising yield is not always a positive signal. It can reflect a falling share price, which may indicate that the market has concerns about the company's prospects. Therefore, doing your research is very important.

Source: Dividend Data

Dividend yield: a worked example

Here is how dividend yield changes as the share price moves, assuming a fixed annual dividend of 40p per share:

This table illustrates two things. First, yield and price move in opposite directions when the dividend is held constant. Second, a very high dividend yield can be a warning sign rather than a straightforward opportunity, particularly if the share price has fallen sharply. This is sometimes called a yield trap: the yield looks attractive, but the price decline may be pricing in a dividend cut or fundamental deterioration in the business.

Types of dividend

1. Ordinary (regular) dividends

The standard periodic payment, usually paid twice a year (interim and final) or quarterly for US-listed companies.

2. Special dividends

One-off payments on top of the regular dividend, typically following a large asset sale, unusually strong profits, or the return of surplus capital.

3. Stock dividends

Additional shares issued in lieu of cash. The shareholder receives more shares but the value of each share is diluted accordingly.

4. Scrip dividends

Similar to stock dividends; shareholders are given the option to receive new shares instead of cash, often at a slight discount.

5. Property dividend

These are rare. A company distributes non-cash assets such as shares in a subsidiary rather than cash.

What is dividend investing?

Dividend investing is a strategy that prioritises income generated from shareholdings, either as a source of regular cash flow or for reinvestment to compound returns over time. It is particularly popular among investors approaching or in retirement, where regular income from a portfolio is more valuable than pure capital growth.

The strategy can be applied through individual share selection, or via income-focused funds and ETFs that hold a diversified portfolio of dividend-paying stocks. Many UK-focused ETFs, for example, are structured specifically to provide income exposure to the FTSE 100 and FTSE All-Share, which have historically offered higher yields than other major indices.

Dividend reinvestment is a powerful long-term tool. Rather than taking dividend income as cash, reinvesting it buys more shares, which in turn generate more dividends, compounding the position over time.

This being said, all things being equal, a dividend payment arguably leaves you no better off, as the net asset value of the underlying investment simply falls by the value of the distribution.

Many brokers and fund platforms offer automatic dividend reinvestment plans (DRIPs) for this purpose. For investors who prefer a fund-based approach, accumulation ETFs reinvest dividends internally within the fund. This contrasts with distributing ETFs, which pay dividends out to investors as cash.

You can read more about how these structures work in our guide to ETFs and exchange-traded products, and explore options across global markets in our guide to the best global ETFs.

What is a good dividend yield?

There is no universal definition of a “good” dividend yield. It depends on the investor's objectives, the asset class being considered and the wider interest rate environment. As a general reference point, the FTSE 100 currently yields around 3.1%, according to Dividend Data. Against this backdrop:

It is also worth comparing yields against the risk-free rate. UK 10-year gilt yields are currently around 5%,which comfortably exceeds the FTSE 100's average dividend yield. For investors who can access a 5% nominal return without equity risk, the case for individual dividend stocks needs to rest on dividend growth potential, rather than current yield alone. Above 6%, the yield can also be cyclical. In the case of housebuilding or mining companies, for example, dividends are reliant on house and metal prices.

Dividend yield vs dividend cover

Yield tells you how much income a share generates relative to its price, but it says nothing about whether that income is sustainable. For that, investors look at dividend cover, sometimes called the payout ratio.

Dividend cover = Earnings per share (EPS) ÷ Dividend per share

A dividend cover of 2 means the company earns twice what it pays out in dividends, suggesting reasonable headroom. A cover of 1 means all earnings are paid as dividends, leaving no buffer. Below 1 means the company is paying out more than it earns, which is only sustainable from cash reserves in the short term. As a general guide, a cover of 1.5 or above is considered comfortable for most businesses, though capital-intensive sectors may operate at lower levels by convention.

There are examples of dividend ‘heroes’ who have a long history of paying out and are usually well covered. However, long term dividend sustainability (sometimes) means a lower yield.

Source: indieinvestor

How are dividends taxed in the UK? (2026/27)

UK dividend income is subject to tax above the annual dividend allowance. For 2026/27, this allowance remains at £500. Above that threshold, the rate depends on your income tax band. Importantly, the rates changed from 6 April 2026: the basic rate rose from 8.75% to 10.75%, and the higher rate rose from 33.75% to 35.75%, as confirmed by HMRC. The additional rate remains at 39.35%.

Dividends received within a stocks and shares ISA or SIPP are not subject to UK dividend tax, regardless of the amount. This makes tax-efficient wrappers particularly valuable for income investors with larger portfolios. For those comparing fund structures, our guide to index funds vs ETFs covers how distributing and accumulating structures interact with tax planning. Child benefit, funded childcare and student loan repayments, among others, can complicate matters, so it’s advised to seek financial advice being taking any action.

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