One of the first principles in long-term investing is to make full use of annual tax-free allowances, reliefs and wrappers to minimise the amount siphoned off by HM Revenue & Customs.
But with the Treasury coffers in a bad way, several of these tax breaks have been targeted by chancellor Jeremy Hunt as a surreptitious route to boost the government’s tax receipts. Investors will need all their wits about them as the tax year end draws near.
Capital gains tax is a prominent example. Although the CGT rate remains unchanged at 10 per cent for basic-rate taxpayers and 20 per cent for higher-rate taxpayers, the CGT annual exempt allowance — the amount of profit you can take from the sale of investments and other assets without paying CGT — is set to be slashed.
In April it will be more than halved, from £12,300 to £6,000. It will be halved again to £3,000 in April 2024. This year’s reduction alone was estimated by the Office of Tax Simplification in 2020 to pull another 235,000 taxpayers into the CGT net.
Also in April, the tax-free dividend allowance will be slashed from £2,000 to £1,000 — affecting an estimated 54 per cent of those receiving taxable dividend income, according to the government. A further cut, to £500, will take place in 2024.
At the same time, more people are being dragged into a higher income tax bracket, regardless of whether or not they invest, after tax thresholds were frozen until 2026 in the 2021 Budget.
Thus, while persistent inflation is underpinning more generous pay increases (the average pay rise was 6.4 per cent between September and November 2022, according to the Office for National Statistics), tax thresholds are not moving to accommodate rising earnings. HMRC has estimated that 6.1mn people will pay higher or additional rate tax in 2022-23, a 50 per cent increase on 2019-20.
Hunt’s announcements in the last Budget exacerbated that trend: the freeze on the higher tax rate threshold at £50,270 was extended until the 2027-28 tax year, while the additional tax rate impacting the highest earners is due to be reduced in April, from £150,000 to £125,140.
As someone moves into a higher tax band, that affects the amount of tax they pay not just on earnings but also on savings and investments — reducing the value of some allowances (for example the personal savings allowance once you’re earning above £100,000) and also increasing the tax rate.
What can investors do? As Ammo Kambo, financial planner at wealth manager RBC Brewin Dolphin, says: “There are several ways of mitigating CGT and dividend tax, but holding investments in an Isa is by far the simplest option. And you don’t need to declare Isas on your tax return, helping to reduce your day-to-day administration.”
Everyone has a £20,000 annual Isa allowance, so investments or savings up to that amount held in an Isa can grow free of capital gains or income tax indefinitely, and there is no tax to pay when the money is withdrawn.
However, this tax year’s Isa allowance is lost forever if you don’t make use of it before the end of the tax year, so it’s important to act promptly. The basic idea is to move “unwrapped” (taxable) investments that might be subject to either dividend tax or CGT on profits when they are sold into the shelter of the Isa wrapper.
Luke Ashton, private client director at Brooks Macdonald, points out that some investors will have far more in capital than they have Isa allowance remaining, and will have to decide where their priorities lie.
“In that case, it could make sense to transfer into the wrapper those investments that you expect will be most likely to yield high dividends or create larger capital gains in the long term,” he says.
Depending on your tax position, dividends can be taxed at differing rates of 8.75 per cent, 33.75 per cent or 39.35 per cent, so it can be sensible to prioritise high-yielding assets within a tax-protected Isa, says Kambo.
“Holding investments targeting capital growth rather than income in an Isa may be less efficient, because crystallised gains are taxed at lower rates than dividend or savings income (for higher rate and additional rate taxpayers). In addition to this, capital losses can be offset against gains.”
Provided you still have some Isa allowance unallocated, you can make transfers through a process known as “bed and Isa”. This involves selling an investment, crystallising any profits within the current year’s £12,300 capital gains exemption, and then repurchasing it (or another investment) within an Isa to ringfence it from future tax. But watch out for any CGT liability that could arise if your gains exceed £12,300.
Given that the CGT exemption will only shrink dramatically from this year onward, it may make sense to crystallise gains up to their full value, even if you do not have sufficient Isa allowance to bed and Isa the whole lot. Any excess proceeds can always be reinvested and transferred next tax year.
Most online brokers offer a bed and Isa facility which makes the whole process relatively simple for customers. However, Henrietta Grimston, associate director of financial planning at Evelyn Partners, says: “Those considering the bed and Isa process need to move fast now, as it can take a bit longer than simply opening an Isa.”
Married couples and civil partnership should be looking to make full use of both sets of Isa allowances to protect existing taxable investments, which may involve transferring ownership between partners. “Transfers between spouses do not count as a potentially taxable event — unlike those between non-married couples — and so switching assets can help maximise tax efficiency,” says Grimston.