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Investors were always going to face higher taxes in Labour’s first budget. For weeks now the Government has been warning us of the unpleasantness that is coming, now in ten days.
Sir Keir Starmer has warned the budget will be “painful” and will require “big demands” from the public. And he threatened that those with “the broadest shoulders should bear the heaviest burden” – and there is no world in which investors are excluded from that field.
But finally last week some details began to emerge about how badly investors could be affected.
Here’s what we know so far – and what it could mean for your portfolio at best – and if Chancellor Rachel Reeves doesn’t mince her words.
What we know so far
Investors will almost certainly pay more tax on their gains in the form of capital gains tax (CGT).
Investors pay CGT when they make a profit from selling valuable possessions, such as jewelery or paintings, shares or property that is not their main home.
At the moment, basic rate taxpayers pay 18 per cent on profits made from selling property and 10 per cent on profits from other assets such as shares.
Last week some details began to emerge about how badly investors could be affected by Chancellor Rachel Reeves’ budget.
Higher-rate taxpayers pay rates of 28 percent on property and 20 percent on other assets. Raising these rates would be the easiest way to increase tax revenue, but until last week we had little idea of how far the Government could go.
The first clue came on Monday, when Keir Starmer was asked whether capital gains tax could be increased to 39 per cent. “It’s getting to the area that’s off the mark,” he said.
The second clue came on Thursday, when reports indicated that Chancellor Rachel Reeves had ruled out increasing CGT on second home property sales.
Phew. A big relief for homeowners and second homeowners, and not a big loss for the Treasury either.
In fact, figures from the Office for Budget Responsibility suggest that raising the rate on second homes would actually reduce tax revenue because it would discourage homeowners from buying and selling.
In any case, only 12 percent of the capital gains tax collected comes from property; more than half comes from the sale of shares.
The news was not so positive for investors: the Chancellor would have decided to increase the CGT on the profits obtained from the shares.
How much will investors pay?
There were fears that the Chancellor would align CGT rates with income rates, which would mean doubling the rate investors pay.
Armed with this information, we can begin to calculate how much more taxes investors will have to pay.
Firstly, any investments held within a pension or Isa package are completely protected from capital gains tax, so they will not be affected by any increases.
Secondly, investors are allowed to make £3,000 profit each year by selling shares outside the wrappers tax-free, without paying CGT.
The Government could choose to reduce or even eliminate this limit, but that would be quite extreme. The allowance has already been slashed, falling from £6,000 last year and £12,300 the year before. Extreme, but unfortunately not impossible.
Investors who make profits from shares held outside the tax-free wrapper (and exceeding £3,000 in a tax year) will face higher capital gains.
There were fears that the Chancellor would follow the recommendation of the Institute for Fiscal Studies think tank and align CGT rates with income rates. That would mean doubling the rate investors pay.
But as Sir Keir Starmer has suggested 39 per cent is a long way off the mark, a smaller increase seems more likely.
One option that might start to look like a Goldilocks-style sweet spot to the Chancellor would be to increase share sales rates to the same rate for residential properties. Currently, this is 18 percent for basic taxpayers and 28 percent for higher rate taxpayers. You could argue that such a move would reduce complexity, increase tax revenue, and keep taxes on second-home owners unchanged while raising them for stock market investors.
Wealth and Personal Finance has asked wealth managers Evelyn Partners to crunch the numbers to see what this could mean for your portfolio.
We asked him to consider three options. Option one – (very illusory) – leave things unchanged. Option two: Raise capital gains tax rates for stocks to the same level as property. Option Three: Choose option two and get rid of the annual allowance. Calculations show that it is basic rate taxpayers who would see the biggest jump.
But as Sir Keir Starmer has suggested 39 per cent is a long way off the mark, a smaller increase seems more likely.
Currently, a basic rate taxpayer making a profit of £10,000 would pay a minimum of £700 in CGT. If CGT on shares were equal to that on properties, they would pay at least £1,260 (an extra £560). Higher and additional rate taxpayers facing the same change would pay an extra £280, a total of £1,680.
If the annual allowance were also removed, basic rate taxpayers would pay more than double the amount of CGT they currently pay – a minimum of £1,800 with a gain of £10,000.
Higher and additional rate taxpayers would pay £2,400; in other words, an extra £1,000.
So how can you protect yourself?
The key is to think things through carefully and not make hasty decisions that you will later regret. Calculate what capital gains liabilities (if any) you may have. It is possible that once you have used your Isa and your current allowance, it may be non-existent or minimal and therefore unlikely to be seriously affected by a CGT increase.
But remember that there is nothing stopping the Chancellor from introducing changes overnight (former Chancellor George Osborne did in 2010), so it may be worth thinking about it now, if you can.
When it comes to protecting you from CGT, Isas are your best friend.
If you haven’t used up your entire £20,000 Isa allowance yet, you can sell shares at a profit within your current £3,000 tax-free allowance and then buy them back into an Isa. Once in an Isa, all interest, dividends and capital gains earned are tax-free.
If you hold your shares on an investment platform (such as AJ Bell, Interactive Investor, Hargreaves Lansdown or Fidelity), they should manage this process (known as a “bed and Isa”) for you. But you will have to move.
If you have used up your Isa allowance, it may still be beneficial to sell shares at a profit up to the value of your CGT allowance and then buy them back outside of an Isa. That way you reset the purchase cost for future CGT assessments.
However, you must wait at least 30 days before buying back shares, and at a time of increased market volatility this is not without risk. Do your research and think carefully before acting.
Another option is to transfer the investments to your spouse, as this will not trigger capital gains taxes.
If your spouse hasn’t used up their tax-free allowance or Isa allowance and you have, you could transfer your investments to them.
Charlene Young, pensions and savings expert at AJ Bell, warns: “Just make sure you write down the original cost of the asset, as that is what will be used when your partner comes to sell it.” He adds that there is another advantage if your partner is a basic taxpayer and you are a higher or additional rate taxpayer, as the current rules mean they would pay capital gains at a lower rate.
Another option is to use investment losses realized in the current tax year to offset any gains before deducting your tax-free allowance. You can also carry forward losses to offset profits in future tax years if you haven’t used them yet.
If your spouse hasn’t used up their Isa allowance and you have, you could transfer your investments to them. AJ Bell’s Charlene Young recommends taking note of the asset’s original cost
A third useful trick is to use pension contributions to reduce your income tax bracket. When you pay into your pension, it has the effect of widening your basic rate tax band. If you have just fallen and become a higher or additional rate taxpayer, you may be able to get back below the threshold by paying into your pension.
That would mean you could pay capital gains at a lower rate.
“This planning tool works with the current system, but if CGT rates are equalized it would no longer be beneficial,” adds Young.
Remember that the Chancellor may have other tricks up her sleeve to increase her appeal to investors. For example, your CGT liability currently dies with you, but she could make it payable at the time of your death if it has not been paid during your lifetime.
Is the Chancellor becoming the pension destroyer Brown?
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