The forgotten tax allowance to take centre stage

David Smith, Financial Planning Director at Tilney Bestinvest says that while pensions have never been so attractive, there is a limit to Osborne’s generosity - and advocates the use of the ‘under-utilised’ Capital Gains Tax allowance

Chancellor George Osborne’s three steps for raising the tax take from pensions:

• March 2014: The introduction of pension freedom legislation; this will create a tax bonanza for over 55s who access their pensions via lump sums beyond the tax free allowance.
• March 2015: A 20% reduction in the Lifetime Allowance to £1 million; over and above which a punitive levy will apply.
• July 2015: A reduction in tax relief on pension contributions for high earners? It was in the Tory manifesto

David Smith comments: “For those looking to save tax efficiently, pensions have become more attractive than ever. It’s clear to see however, that there is a limit to Mr Osborne’s generosity, and that tax benefits are likely to remain capped - at least for the foreseeable future, and potentially reduced for higher earners. For many therefore, it is time to contemplate other means of saving, and maximising all available tax allowances beyond pensions. Whilst I would always advocate that individuals seek to utilise their annual ISA allowances, those already fully utilising ISAs but with further cash to invest can still benefit from tax-efficient investing through good use of other tax allowances.

“One such allowance that is very under-utilised is Capital Gains Tax (CGT). Each year an individual can realise up to £11,100 (2015/16 tax-year) in capital gains before tax will become payable. Where a married couple own an asset jointly, a gain of £22,200 (2015/16 tax-year) would need to be realised prior to tax becoming payable. Indeed, the inter-spouse exemption allows assets to pass between partners without it being classed as a disposal for CGT purposes. 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.

“Many people have, over the course of time, amassed portfolios of funds, investment trusts and shares, and/or investment properties, all of which are assessable to CGT. However, assets only become assessable to CGT when a disposal event occurs, which could be via the sale of the asset or the transfer of the asset to anyone other than a spouse. Unless a disposal takes place, the annual allowance is therefore never called upon, nor can it be carried forward to future years; effectively a valuable benefit lost. 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 etc.

“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. The benefit being, that upon reinvestment, the base cost used in the CGT calculation will essentially be reset to a new higher level, thereby reducing potential CGT liabilities in the future. This is how a portfolio of £100,000 achieving a net growth rate of 5% per annum over 20 years*, could lead to the investment being valued at £265,329 at the end of the term, and never become subject to tax (assuming the CGT allowance increases at 2.5% per annum and no other capital gains are realised each year). On the other hand, an investor in the same scenario who chooses not to utilise their CGT allowance each year, could be liable to CGT of over £41,000 (based upon today’s prevalent rates) on the total gain made.

“The above aside, CGT is only (currently) chargeable at 18% for gains falling within an individual’s available basic rate Income Tax band and 28% for higher rate and additional rate taxpayers. This is in comparison to Income Tax on other savings vehicles at 20%, 40% or even 45%. Investments subject to CGT rather than Income Tax are therefore very attractive even ignoring the use of the aforementioned annual exemption.

“Nevertheless, there are issues to be reckoned with; although some of the more active Investment Managers and Discretionary Fund Managers look to utilise CGT allowances as a matter of course, individuals carrying out sales of funds / shares could incur transactional costs. Furthermore, there is the issue of being ‘out-of-market’, as the proceeds from a sale must not be reinvested into the same asset before a period of 30 days has elapsed. During those 30 days, the investor’s monies will not benefit from any market growth. Of course, the investor could immediately reinvest into an alternative asset, but this may not always be appropriate. One way to simplify this process for investments held outside of ISAs or pensions is to invest through a multi-asset fund, as transactions within the fund are not subject to CGT. Please note that the investment itself may be liable to CGT in the hands of the investor.”

Utilising CGT for retirement income

Smith continued: “So far I have focused on the benefits of utilising the annual CGT exemption during periods of capital growth, but using the CGT allowance is also 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. 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.

“Ultimately however, in an age when the personal allowance is typically absorbed by earned income and owing to the current squeeze on pension tax benefits, investors must look to alternative methods of making tax savings. The CGT allowance can certainly play a part in an overall, tax efficient portfolio.”

*Compounded annually. Gross of tax and charges. Investments can go down as well as up. Figures shown are for illustrative purposes only.

Important information:

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This press release does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.

Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. Please note we do not provide tax advice.

David Smith can be contacted on 0191 269 9970 / david.smith@tilneybestinvest.co.uk

-Ends-

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roisin.hynes@tilneybestinvest.co.uk

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matthew.gray@tilneybestinvest.co.uk

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About Tilney Bestinvest

Tilney Bestinvest is a leading investment and financial planning firm that builds on a heritage of more than 150 years. We look after more than £9 billion of assets on our clients’ behalf and pride ourselves on offering the very highest levels of professional client service with transparent, competitive pricing across our entire range of solutions.

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