Capital Gains Tax (CGT) continues to be a topic of much discussion, with every new government taking its own approach to simplifying or complicating the process. As of April 2024, we’ve seen some notable changes, and with more shifts potentially ahead, it’s worth examining how this tax impacts your investments and whether the changes are a positive or negative development.
What’s New with Capital Gains Tax?
As of April 2024, the most significant change to CGT is the reduction in the higher rate on residential property from 28% to 24%. Alongside this, the annual CGT allowance has been cut down to £3,000 from the previous higher amounts, which reached £12,300 during the 2020/21 and 2022/23 tax years.
While a reduction in tax rates is typically seen as a good thing, the reduction in allowances is more controversial. This change means that a larger portion of your investment gains could become taxable, especially if you’re selling assets held outside tax wrappers like ISAs or pensions. Previously, larger allowances allowed more flexibility in managing taxable gains, but now, a portfolio rebalance that once incurred minimal or no CGT could result in a higher tax bill.
Is Paying CGT Really That Bad?
Let’s put things into perspective: CGT rates are at the lowest they’ve ever been. Historically, CGT rates have been as high as 30%, but now, they’ve settled at a much more affordable 10% or 20%. This makes realizing gains more tax-efficient compared to previous years.
So, is paying CGT that bad? Not necessarily. The tax only applies to the growth on your assets, not the capital you initially invested. The fact that your assets have grown enough to incur CGT is, in itself, a sign of solid financial decision-making. In fact, would you rather face a tax liability from your growth, or have no gains to tax at all?
Dividends and Interest Rates: A Taxing Scenario
While CGT might seem manageable, other areas of taxation could be a concern. Dividend allowances have shrunk to £500 for the 2024/25 tax year, which means more people will pay taxes on their dividends. Similarly, with rising interest rates, savings and bond income is now more likely to be taxed at higher rates, ranging from 20% to 45%, depending on your income.
By holding onto assets that generate income (such as dividends and savings interest) without addressing the CGT liability, you might actually end up paying more in taxes in the long run. Paying CGT at a rate of 10% or 20% might be preferable to the higher taxes you’d face on dividends and savings interest.
Inheritance Tax Implications
One of the often-overlooked consequences of not addressing CGT in your lifetime is its potential link to Inheritance Tax (IHT). Currently, if you pass away, the value of your assets is revalued at the time of your death, and any unrealized gains are effectively wiped out for IHT purposes. However, if you hold on to your assets and leave them untouched, your heirs could inherit them with significant IHT liabilities, especially if the value of those assets exceeds the IHT threshold.
For example, imagine holding £300,000 of company shares with an unrealized gain of £150,000. If you sell them during your lifetime, you’d face CGT of up to £30,000. However, if you do nothing, those same shares could be passed on to your heirs, who may end up paying £120,000 in IHT, a much higher price than the CGT you would have paid.
Diversifying Your Portfolio: A Key Strategy
By not taking action on your gains, you risk having a portfolio that is overweight in certain assets, which could expose you to greater risk. While it may feel uncomfortable to pay taxes on your profits, doing so allows you to continue managing your investments without restrictions, helping you maintain a diversified and balanced portfolio. Taxes should never hold you back from making wise investment decisions.
Why It’s Time to Take Action
Now more than ever, paying CGT could be a strategic move. With tax rates at their lowest in decades, this is an opportune time to realize gains at minimal tax cost. The goal is not to let the fear of taxes prevent you from achieving your financial goals and enjoying the rewards of your investments.
Rather than holding onto assets and risking higher tax liabilities in the future, consider proactively managing your portfolio and making the most of the current tax rates. Tax laws may change, but with proper planning, you can reduce your tax bill and ensure your investments continue to grow efficiently.
In summary, while the reduction in CGT allowances may feel like a setback, it presents an opportunity to take action while tax rates remain relatively low. By carefully managing your investments, you can minimize tax liabilities, diversify your portfolio, and enjoy the fruits of your financial decisions without waiting for tax laws to change further.
