How to prepare for April's tax hikes

Jeremy Hunt’s focus on national insurance cuts in his Spring Budget earlier this month did not change the fact that taxes are going up for a number of people. Among this group are investors, who are facing important reductions in both the capital gains tax (CGT) and the dividend tax allowances.

The CGT allowance decreased from £12,300 to £6,000 last April, and will be halved again to £3,000 from next month. For an investor in the higher income tax band, this means a tax hike of up to £1,260 between 2022-23 and 2023-24, and another £600 on top of that for all subsequent years from 2024-25.

Similarly, the dividend tax allowance was cut from £2,000 in 2022-23 to £1,000 in the current tax year, and will fall to £500 as of April. For higher-rate taxpayers, this equates to an increase of up to £337.50 this year, and an additional £168.75 from next year. Factoring in both dividends and capital gains, the maximum hike a higher-income investor faces due to these cuts stands at £2,366.25.

These hikes have made tax efficiency more important than ever. You should start with the basics: put as much of your investments as possible into a tax wrapper, making the most of your £20,000 annual individual savings account (Isa) allowance, as well as your pension. After all, investment growth compounds quickly, which while great for investors might also mean you find yourself sitting on a big CGT bill faster than you think.

For investments in unwrapped accounts, you should make use of the allowances while they are available. If you are sitting on significant gains in these accounts, it might be worth crystallising some before the end of this tax year, given that, just like the Isa allowance, both the CGT and the dividend allowance operate on a 'use it or lose it' basis. If you don’t need the money, you can then always pay it into your Isa: one way to do so is by using a so-called bed & Isa transaction.

It is not all bad news: keep in mind that the CGT allowance relates to only the gains, rather than the full value of the investments that you sell; gains can also be offset against losses which, unlike the allowances themselves, can be carried forward to future years – provided they are reported to HMRC within four years from the end of the tax year in which the asset was disposed. 

An income problem

Capital gains tax rates for non-property assets stand at 10 per cent if you are a basic-rate taxpayer, and 20 per cent if you are a higher-rate taxpayer. Meanwhile, dividends above the dividend allowance are taxed at 8.75 per cent for basic-rate taxpayers, 33.75 per cent for higher-rate taxpayers and 39.35 per cent for additional-rate taxpayers. Depending on which tax band you fall into, there are a few options to consider, particularly if you are married or in a civil partnership.

Rachael Griffin, tax and financial planning expert at Quilter, says couples should review which of them owns which assets, and consider transfers if necessary. “Since both CGT and dividend taxes are influenced by your income tax band, transferring assets to a partner in a lower tax band can result in significant savings. This can ensure that future gains or dividends are taxed at a lower rate,” she explains. You should also divide the assets strategically to ensure that both partners are making the most of their respective allowances, minimising the overall tax liability for the household, she adds.

If you expect your income tax band to drop in the near future, for example because you will retire and your income will decrease, it is worth thinking about the timing of cashing in any gains above the allowance. Waiting a couple of years, if possible, could easily save you hundreds or thousands of pounds. 

Depending on your tax band, also think about which assets to prioritise holding in an Isa. Your investment strategy shouldn’t be influenced by tax considerations – ultimately CGT and dividend tax bills are nice problems to have. But if you are a higher or additional-rate taxpayer, dividend tax rates are far higher than CGT rates, so income-generating assets, particularly those with higher yields, should be the first to be protected in a wrapper.

Laura Suter, director of personal finance at AJ Bell, notes that the FTSE 100 is forecast to yield 4.2 per cent this year, meaning an investor in this index only needs a £12,000 pot to hit the dividend tax allowance for 2024-25. Meanwhile, some FTSE 100 companies are forecast to deliver a dividend yield of 10 per cent or more: investing solely in these assets would bring the figure down to £5,000. “If your non-Isa investment pot is larger than your allowances, the smartest move is to prioritise shifting your biggest dividend-paying investments into your Isa first,” she says.

Pension contributions

Pensions are attractive because you get tax relief on your contributions, your investments grow in a tax-free environment and they are also sheltered from inheritance tax (IHT) once you pass away. If you have unwrapped investment gains to cash in, there might be an additional benefit, depending on your income level.

“By increasing your contributions to a pension, you can reduce your taxable income, potentially extending your basic-rate tax band. This is particularly beneficial for CGT purposes since assets disposed of within the basic-rate band are subject to a lower CGT rate,” says Griffin. “For those hovering near the threshold of higher income brackets, boosting pension contributions can be a dual-benefit strategy, aiding both your retirement savings and your immediate tax situation.”

Finally, a more sophisticated option is to consider investments offering tax advantages, such as venture capital trusts (VCTs) or Enterprise Investment Scheme (EIS) companies. These are riskier investments, so something of a last resort for sophisticated investors, especially in the case of EIS. But both come with 30 per cent income tax relief. VCTs pay tax-free dividends and are free of CGT, while EIS gains can be realised over a number of tax years or rolled into a new EIS when the shares are sold. An EIS is also free of inheritance tax as long as you have held it for at least two years at the time of death.