Changes to dividend taxation which come into effect from next April could mean savers and investors holding dividend paying investments outside individual savings accounts (Isas) and self invested personal pensions (Sipps) could lose out. However there are a number of ways you can use financial planning to help mitigate the impact of this.
Investors who have used up their annual Isa allowance which is currently £15,240, and pensions annual and or lifetime allowance - £40,000 and £1.25m respectively - can make use of their annual capital gains tax (CGT) allowance. For the 2015/16 tax year this is £11,100 in capital gains before you pay any tax.
"Instead of relying on dividend income you could cash in growth investments every year within your CGT allowance and use the lump sum to spend as income," suggests Jason Hollands, managing director at Bestinvest. You cannot carry forward the allowances but this works well for taking out annual withdrawals within the limit.
Where a married couple or civil partners own an asset jointly they can make gains of £22,200 before incurring tax. And they can pass assets between each other without it being classed as a disposal which incurs CGT. "This means that individuals can pass all, or part, of their portfolio to a spouse who may have more CGT allowance available, or who may be subject to a lower rate of CGT on disposal," says David Smith, financial planning director at Tilney Bestinvest. "Using the CGT allowance is a valuable facility in enabling retirees to generate a tax-efficient income in retirement. Given that no tax will be payable on capital gains unless the annual allowance is exceeded, an individual could withdraw capital without exceeding the allowance to generate a tax-free income to supplement their other income. And when you consider that a married couple could withdraw at least £22,200 per tax-year without any tax liability being incurred, utilising annual CGT allowances can enable a substantial tax-efficient income to be generated."
Even after you have used up your annual allowance, CGT is chargeable at 18 per cent for gains within your basic-rate income-tax band, and 28 per cent for higher and additional rate taxpayers. This is lower than income tax at 20 per cent for basic rate taxpayers, and 40 per cent and 45 per cent for higher and additional rate taxpayers. For higher and additional rate taxpayers it is also lower than the levels of dividend tax they will incur from April 2016 after they have used their £5,000 allowance.
Selling a portion of your assets every year within your CGT allowance is also an efficient way of drawing down a large portfolio of funds, investment trusts, shares and investment properties, all of which are assessable to CGT. "Unless a disposal takes place, the annual allowance is therefore never called upon, nor can it be carried forward to future years so effectively a valuable benefit is lost," says Mr Smith. "As a result, many investors are hit with sizeable tax liabilities when they eventually come to surrender and/or transfer long-held assets to children. But with careful ongoing planning however, some, or all of a portfolio can be sold to fully utilise an individual's annual CGT allowance - without ever creating a tax liability."
Example Using your annual CGT allowance could enable a portfolio of £100,000 achieving a net growth rate of 5 per cent a year over 20 years to return £265,329 at the end of the term and never be subject to tax*. The investor would realise any gains made during each tax-year within their available CGT allowance - £11,100 for the 2015/16 tax year - and by doing this effectively increase the base cost for future capital gains purposes. The 5 per cent return on £100,000 made during the initial year is locked in by selling or switching out of the fund that had made the gain and subsequently reinvesting the monies. As this gain would not exceed their capital gains allowance, no tax would be payable and the base cost moving forward would be the £105,000. This would then be repeated every year and at the end of 20 years investment period, the gain on £265,329 would be within the CGT at that point enabling the investment to be surrendered without capital gains tax being payable. "But an investor in the same scenario who chooses not to use their CGT allowance each year, could be liable to CGT of over £41,000 (based on today's prevalent rates) on the total gain made," says David Smith at Tilney Bestinvest. *Example assumes that the CGT allowance increases at 2.5 per cent a year and no other capital gains are realised each year. Source: Tilney Bestinvest |
For capital gains tax purposes, gains made can't be reinvested into the same asset for at least a 30-day qualifying period. This means that during those 30 days, your monies will not benefit from any market growth. You could immediately reinvest into an alternative asset, but this may not always be appropriate.
A way to mitigate this for investments held outside Isas or pensions is to invest in a multi-asset fund, as transactions within the fund are not subject to CGT, when the manager makes a profit on one holding and reinvests it in another. You could sell units or shares in the fund within your CGT allowance. But it means that you do not have control of the asset allocation or investments held, and multi-asset funds can have relatively high charges.
We include some multi-asset funds with more reasonable charges within our IC Top 100 Funds list. These are Personal Assets Trust (PNL) with an ongoing charge of 0.93 per cent, RIT Capital Partners (RCP) with a charge of 1.25 per cent and Ruffer Investment Company (RICA) at 1.18 per cent.
