There has been lots of speculation in the run up to what has been the most highly anticipated budget in a long time. Many different theories are being thrown around, but one of the most common and most probable is an increase in the rate of capital gains tax (CGT).
Given that Labour is historically the party of the worker, they have made it clear that they won’t increase income tax or National Insurance (or VAT, for that matter) preferring to raise taxes on wealth – whether through investments or pensions.
As capital gains tax is currently much lower than income tax, it seems quite likely that it will be increased in some way, even perhaps to parity.
As the previous government actually cut the capital gains allowance that you could make tax free from £12,300 to £3,000 in the last couple of years, this is something that will likely affect far more people than perhaps it would have done before.
This is a complex topic and very individual, however I wanted to put together some pointers that may be able to help people to hold on to more of their hard-earned money.
Please note, as usual at Moneyfarm we don’t make any direct recommendations and any decisions should factor in your own circumstances, investment needs and risk appetite.
Use tax-free wrappers – ISA, pension and JISA
Not the most groundbreaking piece of guidance but absolutely crucial. Hopefully there aren’t many people left in our client base who don’t understand the value of these tax wrappers but with capital gains allowances falling and tax rates now potentially increasing, it’s becoming even more important that people use the reasonably generous allowances available to them to save for their future.
Each wrapper has a set of rules and purposes – designed for different needs which I won’t go into now. However this should certainly be step one of any plan.
Gilts below par
Interestingly, government bonds are not such a widely used savings vehicle in this country compared to what we see on our Italian side of the business, for example.
However, gilts will now be taking on even more importance, as you don’t pay any capital gains tax on them (although you do pay income tax on the interest – as with all bonds & cash savings, so be careful).
We have a dedicated collection on our share investing platform of ‘Gilts below par’. These are gilts released in periods when rates were around 0.5%. So the income received (income is taxable) is very low, however as a result their price is really low. For example:
The gilt shown above will only pay 0.625% per year in coupons, which is good if you don’t want to pay income tax (which is currently higher). However, on 31 July 2035, this will pay back the par value of £100. So, every unit that you buy for £71.94, will return £100 on that date.
So nearly all of the return is capital gain and little in terms of income.
Please note there are many available options and the price will vary from writing this, I am simply using this one to describe the mechanics.
So for an instrument that is capital gains tax free, this is an interesting proposition and if you have savings that you have to make outside of your tax wrappers, then it’s certainly something to consider.
As mentioned above, gilts are not income tax free, so the ones on our platform with an income of more than 5% (which will likely be selling above par) are not tax efficient. Although they could be attractive if you want good risk adjusted returns within an ISA.
Tax loss harvesting – ‘bed and breakfasting’
This is not a move to be taken lightly, so if something that you think is relevant to you, please speak to someone to understand it properly to see if it’s right for you. I am simply describing it at a very high level.
A crucial rule for this strategy is that if you sell an instrument, you can’t rebuy the same one for 30 days. You can park the money in money-market funds, like our Liquidity+ offering, for example, for 30 days or choose a different instrument.
However, the basis for using this are along 2 different lines:
- Capital losses can be used to offset capital gains – for the next 3 years
- By selling and rebuying an instrument, you can reset the ‘purchase price’ for future calculations (locking in some capital gains)
The first use is quite obvious: when an investment is in a loss-making position, you can sell it – crystallising that loss – which can then be used for the next few years to offset any capital gains in those years.
But it’s important to note that you may be out of the market for the next 30 days, so if the portfolio has just fallen, there’s a chance there is a big bounce (regular readers will know that the ‘best days come after the worst days’), so you have to be careful. Missing a big bounce is probably not worth the potential tax benefits.
The second use, again, used to be more relevant when there was a £12,300 allowance, as you could ‘lock in’ £10,000 worth of capital gains, for example, reset the buy price higher – meaning that future gains would be calculated against a higher starting base for CGT calculations.
This is still relevant for the £3,000 allowance that we currently have, but is more difficult to manage and the benefit could be lost quickly by having to spend 30 days out of the market.
However, if tax rates are due to rise as touted, you could consider ‘locking in’ your gains in this tax year, where tax rates are at 10% and 20%, setting a new, higher starting base for future years where the rates are going to be higher.
Again, I am not directly recommending this to anyone – simply highlighting it as an avenue to explore further. There are cons to this process as well, such as being out of the market (as mentioned before) and trading costs (if you are in such an investment), to name a few.
Another thing to consider is that if you have a big capital gain position now and sell everything to realise the big gain and start again, then you could face a big tax bill all at once. Whereas in the future, you may have only planned on taking money out of the portfolio in smaller chunks – so perhaps paying a higher rate – but a smaller and more manageable amount.
So it’s worth thinking about what your plans are explicitly to understand whether this is relevant to you or not.
Put longer-term, higher growth assets into tax wrappers
Again, here you need to be very careful as there are many moving variables. For example, as it currently stands, income tax (paid on cash interest) is a higher % rate than CGT rate. Also, depending on your status, your income might be low and capital gain high – so you need to think about that when structuring your assets (for example, if you’re a retiree with lots of assets saved, but below the personal tax allowance for income, you may need to think about what type of return is best).
However, if you have some short-term assets, or short-term cash, the level of return you are likely to accrue is lower than perhaps your 10-year investment pot.
For example, £50,000 in a 3% cash account for 2 years, will give you £3,045 in interest, o/w only £2,045 is taxable for a higher rate taxpayer – only £1,045 for basic rate. As you get £500/£1000 per year allowance.
However, if you were to put that £50,000 in an investment portfolio for 10 years, that gives you 6% net per year on average – you would end up with a c.£39,540 return. Assuming all is capital gain and is taken at once, then £36,540 is taxable by current rules (£3,000 allowance).
So it would definitely be better – all else equal – to have put the second £50,000 into tax wrappers.
So, if you have a few different goals to weigh up and limited contribution space to take up – this is certainly something to consider.
However, there is obviously nuance around the way that investments are drawn down, which can complicate matters. If not all is taken at once, the money taken out is staggered, this can change the equation. However, hopefully the basic premise can help you with your decision making.
Speak to us
Again, this is a big and complicated topic, but hopefully these high level descriptions of different methodologies can help. I want to add that we are not tax advisers, but we can share our views and understanding in order to help you to have a clear picture.
Please feel free to book a call with our friendly team about this or any other topic touted in the upcoming budget. Whilst we can’t directly give any advice or recommendations – we can help to describe these processes further in order to help deepen your understanding.
If you have any questions for me directly – or actually anything else budget related that you would like our views on, please feel free to email me directly on christopher.rudden@moneyfarm.com.
*Capital at risk. Tax treatment depends on your individual circumstances and may be subject to change in the future.
