Capital gains tax (CGT) is expected to raise £17.8 billion1 for the government this tax year. That’s roughly £350 per adult in the UK2, highlighting the hefty tax bills that investors could face once they cash in their investments.
These tax bills are also set to rise further due to cuts in the annual tax-exempt allowance. The amount of profit you can realise on your investments without incurring a CGT bill was more than halved to £6,000 this tax year. It is set to halve again to £3,000 from 6 April 2024.
What this means is that any profit you make over and above these levels when selling your investments – be they shares, bonds, funds (including exchange-traded funds) or business assets – incurs a CGT charge. This tax rate is set at 10% or 20% of the total gain3, depending on your other income.
So, what can investors do to limit their CGT exposure?
Make maximum use of tax-efficient wrappers
The most obvious thing is to make the most of individual savings accounts (ISAs). Alternatively, if you’re happy to lock in money until your mid-to-late 50s4, make the most of your pensions, including self-invested personal pension (SIPP).
This is because both types of account protect your investments from CGT (as well as other types of tax).
It never ceases to amaze me how many high-net-worth investors make insufficient use of ISAs. Some don’t realise that the current ISA allowance is £20,000 a year and that capital gains are tax-free on all ISA investments, no matter how big they may get over time.
Others simply don’t get round to it.
But I also see diligent investors with ISA portfolios of £500,000 or more, who have effectively removed all concerns about CGT by thinking about the long-term and planning ahead.
Bed and ISA, Bed and SIPP
Don’t think you’ve missed the boat if your investments aren’t already organised within ISAs or pensions, because you can still do something about your potential future CGT liabilities.
You can top up your ISA and/or SIPP with the proceeds from the sale of your existing investments rather than with new money in a two-step operation known as ‘Bed and SIPP’ or ‘Bed and ISA’, respectively.
Although the initial sale would be subject to your annual CGT allowance, funding unused pension or ISA allowances with this money will subsequently mean your investments are moved to a more tax-advantageous position.
You may even earn tax-relief on this money as it will count as part of your annual tax-free pension allowance, which is capped at 100% of your gross earnings up to a maximum £60,0005 but can be carried forward for three tax years.
However, the rules around Bed and ISAs and Bed and SIPPs can be complicated, so investors should consider speaking to their financial adviser first.
Beware also that the more you trade, the harder it can be to work out the gain or loss on your disposals across your shareholdings. In this respect, HMRC has specific rules you must follow, which is more reason to consult a personal tax expert.
Have a long-term strategy
Even if you haven’t got the option to make more use of your ISA or pension, you can still reduce the risk of building up a large unrealised capital gain by using your annual CGT allowance to sell part of a holding without incurring any tax, and then buying it back.
By doing this you can reset the cost of your holding at a higher price and so reduce the potential profit against which future CGT liabilities will be calculated.
Tax rules mean that you have to wait 30 days before you can buy back the same holding back. (If you’re uncomfortable with the out-of-market risk that this implies, you could consider investing in an exchange-traded fund (ETF) offering a similar exposure in the interim).
Take profits sooner rather than later?
In general, the annual CGT allowance is of the “use it or lose it” variety, which means you can’t carry any part of it into subsequent tax years.
So, given it’s already been more-than-halved and is set to be halved again come the next tax year, perhaps there’s more reason to make full use of the current £6,000 allowance, while you still can.
Another option is to delay a capital gain by spreading it over two tax years – selling half or more of the investment on, say, 5 April and the rest on 6 April. This is perhaps not as appealing as in previous tax years, when CGT allowances were higher, but it can still help to spread out when tax is payable.
Make the most of your losses
Don’t let losses go to waste either. No one wants to lose money but if you do make a loss at least use it to your advantage when filing your annual tax return. This is because you can carry forward capital losses on your investments.
So, if you make a loss one year, think ahead to the following tax year.
Since CGT is only charged on your net capital gains, think about offsetting your capital losses against your capital gains every tax year to help reduce what you owe.
Keep it in the family
Something else that can help is the fact that transfers between spouses and civil partners are usually tax-free, which means you have the option to work as a couple to better manage your CGT liabilities.
This is because transferring investments to a spouse or civil partner can help to bring down a CGT bill if they are in a lower tax bracket, don’t work or haven’t fully used their CGT allowance6.
Every individual has their own allowance, which means that each married couple in 2023/24 has the potential to realise tax-free capital gains worth up to £12,000.
Manage your taxable income levels
Since the rate at which you pay CGT is dependent on your income tax band, reducing your income tax rate can have a knock-on benefit on your CGT.
Two other ways to reduce your taxable income, in addition to transferring investments to a spouse, is by contributing more to your pension or making charitable donations.
Invest in shares and bonds through funds
It’s also important to note that investing through well-diversified funds, such as Vanguard’s straightforward and low-cost range, rather than individual shares and bonds7 can also limit your CGT exposure.
This is because investors don’t pay CGT on any of the capital gains that a fund might make when buying and selling different shares and bonds.
It’s only if and when you sell your fund holding at a profit – assuming you haven’t done so inside a tax efficient wrapper such as an ISA – that having to pay CGT becomes a possibility.
And don’t pay twice
A final thing to bear in mind is that capital gains are wiped out upon death since your estate will have to pay inheritance tax. So incurring CGT by selling assets later in life could effectively mean paying tax on the same asset twice. If in doubt, contact your financial adviser.
You can’t choose whether to pay CGT or not. With careful planning, though, you can reduce your potential bill by making the best use of the available reliefs and allowances.
1 As forecast by the Office for Budget Responsibility in April 2022.
2 Based on a breakdown of the UK population, as measured by the 2021 census.
3 Surplus capital gains on residential property are also taxable, but at a different rate. In most cases, your family home is CGT-exempt. However, profits made on second homes or property investments can incur a CGT charge of either 18% or 28%, depending on your other income.
4 The earliest you can access your private pension money is aged 55, rising to 57 from 6 April 2028.
5 This can be tapered for very high earners.
6 Capital Gains Tax civil partners and spouses (2020), HMRC. Updated April 2023.
7 Except for securities issued by the UK government, which do not incur CGT. View full list.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
The eligibility to invest in an ISA depends on individual circumstances and all tax rules may change in future.
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Any tax reliefs referred to in this article are those available under current legislation, which may change, and their availability and value will depend on your individual circumstances. If you have questions relating to your specific tax situation, please contact your tax adviser.
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