We can debate the real meaning of the expression Don’t let the tax tail wag the investment dog, but most of us would agree this is about ensuring you don’t let the smaller stuff control the bigger picture e.g. making a decision on a specific investment without regard to your future finances or overall financial plan.
However, a recent change of government, a continuous decline in the annual capital gains tax (CGT) exemption (together with a reduction in your dividend allowance) and speculation surrounding an increase to CGT tax rates, means that we may need to reconsider the most tax efficient method of holding your overall assets.
Navigating tax-efficient investment strategies in changing times
Lets take it as a “no brainer” that the two most obvious and tax efficient ways to accumulate funds to finance your future lifestyle spending remain pensions (Income tax or Corporation tax relief on contributions, virtual tax-free growth, freedom from Inheritance Tax) and ISAs (no Income Tax or CGT on gains made within an ISA).
The reduction in the annual CGT allowance has started to create a headache if you own investments not held in an ISA and quite logically seek to transfer these investments into an ISA wrapper. This is a disposal for CGT purposes and with the annual CGT allowance now set at £3,000, it is not difficult to be triggering a CGT gain when doing this.
Additionally, if you’re holding investments outside of a pension or ISA and not held within an Investment Bond, any “rebalancing” (the process of ensuring the overall mix of your investment portfolio remains close to your risk preferences and tolerance) also has the potential to trigger a CGT tax charge and you may be asking yourself “should I or shouldn’t I pay CGT to rebalance”?
Setting the rebalancing question to one side, there are advantages of holding investments within an Investment Bond wrapper (either an Onshore or Offshore Bond) as an alternative or alongside holding investments outside of ISAs and pensions.
What is an Investment Bond?
An Investment Bond, not to be confused with Government Bonds, Corporate Bonds or Savings Bonds, is usually a single premium life assurance policy which can hold the same investments you may own within an ISA and a pension but governed by different tax rules.
Similar to an ISA, you can make investments and withdrawals as and when you want.
What are the advantages of Investment Bonds?
Investor taxation – The major benefit of Investment Bonds, whether Onshore of Offshore versions, is the ability to defer the payment of tax. As investment sums become larger, and dividend/interest taxation along with capital gains taxation becomes more relevant, these tax deferring qualities may be valuable.
Investments not held with a pension or ISA will be subject to immediate income tax on any dividends or interest (in excess of your annual allowance). Capital Gains tax will also need to be considered if you wish to “rebalance” as outlined above or if you wish to try and “rebase” any investment to reduce future capital gains tax.
Tax deferred may ultimately be tax saved.
Trust investments – Investment Bonds can be a simpler and more tax efficient option for certain Trusts because they are non-income producing and are not subject to CGT. Furthermore, the 5% tax-deferred annual withdrawal facility can be an effective way for an investor to make regular withdrawals.
Encashment – Investment Bonds may have more potential to reduce or avoid tax when encashing as they can be assigned to any adult as a gift, unlike other investments which may only be transferred between spouses or civil partners living together.
Moreover, if you as an investor can minimise your income tax position when encashing or you expect to be a basic rate taxpayer in the future (having been a higher rate taxpayer when making the investment), additional tax efficient encashment strategies may be available.
The selection of which “tax wrapper” to use to hold any investments will always be based upon assumptions. If these assumptions, as is so often the case, prove to be incorrect, this strengthens the case to have a diversified tax planning strategy alongside a diversified investment solution.
If you have any questions relating to your investments, please get in touch on 01825 76 33 66 or via the form below.
