What are the main tax-planning uses for Isas?
The dividend and capital gains allowances are being cut from £2,000 to £1,000 and from £12,300 to £6,000, respectively, from 6 April – and again to £500 and £3,000 from April 2024. This makes the role of individual savings accounts (Isas) more important than ever. Investments held within Isas do not incur dividend tax, and if you sell them within an Isa they do not incur capital gains tax (CGT). And when you withdraw money from an Isa it does not count towards your income tax liability. “Isas also ease the administrative hassle of completing a tax return every year as investments held within [them] do not have to be declared,” adds Alice Haine, personal finance analyst at Bestinvest.
Isas should be your first port of call for retirement savings if you have entirely used up your annual pensions allowance, which is rising to up to £60,000 from 6 April.
For those seeking retirement income streams, it generally makes sense to draw from Isas before accessing private pensions because while Isa withdrawals are tax free, money taken from pensions, other than the tax-free portion, is taxed at your marginal rate.
Drawing from Isas before pensions is also a good option if you hope to leave assets to children or other beneficiaries. You can pass on Isas to spouses or civil partners tax free, but if given to other beneficiaries they may incur inheritance tax (IHT). However, personal pensions can be passed on to beneficiaries free from IHT. If you die before age 75, beneficiaries can withdraw from the pension tax free and if you die after 75 their withdrawals are taxed at their marginal income tax rate.
Should I move existing investments into an Isa?
If you do not have new money to put into an Isa but have existing investments outside Isas and pensions, transferring these into Isas each year – if your annual Isa allowance is still available – makes sense. This is particularly relevant in the coming days, ahead of the decrease in the annual CGT allowance scheduled for the new tax year.
You can do this via what is known as a ‘bed and Isa’. This is when you sell investments with gains up to the value of the annual CGT allowance, put proceeds worth up to £20,000 in an Isa and buy the investments again.
Bed and Isa deadlines often fall several days before the end of the tax year. For example, investment platform Interactive Investor’s online bed and Isa instruction deadline is 4.30pm on 31 March. Telephone requests will be dealt with on a ‘best endeavours’ basis after this time.
If your CGT and Isa allowances are not enough to transfer all your investments this tax year, and your spouse or civil partner has not used up their allowances, you could give them some of your investments as transferring assets to them does not incur CGT.
It may make sense to sell investments worth more than your annual CGT allowance to move them into an Isa “if you expect to become subject to higher rates of tax in future years or have investments that have made a loss”, says Haine. “In that instance, you could crystallise the loss and offset this against the gains, although always weigh up the investment case for doing this as well as the benefits of using the allowances versus losing them. Excess losses can also be carried forward indefinitely to offset future gains, although the losses must be declared to HMRC within four years of the end of the tax year in which they occurred.”
Bed and Isa can also be useful because it is an exception to the rule that you must wait 30 days before you can buy back the same investments that you sell. But there are instances when it may not be a good idea, such as if you are nearing retirement and have unused pension allowances to use instead.
Should I prioritise income or growth?
Because the annual dividend allowance is smaller than the CGT allowance and you can offset gains against losses, advisers have generally suggested prioritising holding income investments in Isas. Although the CGT allowance reduces drastically to £3,000 from April 2024, it may still be better to first shelter your income-paying investments if you do not have the capacity to immediately transfer both income and growth investments into Isas.
The dividend allowance will remain lower than the CGT allowance at £1,000 in 2023-24 and £500 thereafter.
And dividend tax rates are higher than CGT rates for higher earners. Dividend tax is 8.75 per cent for basic-rate taxpayers, but 33.75 per cent for higher-rate taxpayers and 39.35 per cent for additional-rate taxpayers. CGT on sales of direct shareholdings, funds and investment trusts is levied at 10 per cent for gains which when added to taxable income fall into the UK basic-rate tax band, and 20 per cent for gains which when added to taxable income fall into the UK higher or additional-rate tax bands.
Dividends from investments held outside pensions and Isas also count towards your total annual income, so could push you into a higher tax band.
