Minimising tax – or eliminating a potential tax liability altogether – is one of the key drivers behind most sensible financial planning decisions. Whether using efficient vehicles such as Individual Savings Accounts (ISAs) or pensions, or considering investments that provide tax relief, such as Venture Capital Trusts, achieving a tax-efficient outcome can maximise investment returns; however, there are limited situations where paying tax can be beneficial, and one of these is centred on decisions to crystallise gains where Capital Gains Tax (CGT) becomes payable.
Background to CGT changes
Over the past few years, tax legislation on gains made from the sale of an asset has been tightened on multiple fronts simultaneously. CGT is paid on the profit made on disposal of an asset that has increased in value. There are only limited exceptions where CGT does not apply, for example investments held in tax wrappers such as an ISA or pension, or the sale of your primary residence.
Since 2023, the annual CGT exemption (on which CGT is not paid) has been slashed from £12,300 all the way down to £3,000 in the current tax year. This means that many more investors are now dragged into paying CGT, and for those with larger portfolios, CGT is becoming much harder to avoid. Apart from the reduction in CGT exemption, rates of CGT payable have also increased, with basic rate taxpayers now paying 18% on gains above the exemption and higher and additional rate taxpayers now paying 24%. These rates are 8% and 4% higher respectively than the rates that applied before October 2024.
Practical steps to reduce a CGT liability
There are limited steps you can take to reduce or avoid a liability to CGT. Firstly, using tax-efficient wrappers, such as ISAs, Investment Bonds or Pensions, is a sensible step as gains made within these wrappers are exempt from CGT.
Despite the sizeable reduction in the CGT annual exemption, it is important to make use of the exemption where possible. As we approach the end of the tax year, now is a sensible time to review whether you should take action to make use of the exemption.
Married couples can maximise the use of their individual CGT exemptions by transferring assets to each other. Such transfers between spouses are exempt from CGT and provide the opportunity to take full advantage of both allowances.
A further consideration for those in later life is the uplift assets receive when valued for probate purposes. As the base cost that beneficiaries acquire assets from an estate is reset to the value at date of death, unrealised gains are effectively wiped out under current legislation.
Consider the opportunity cost
With the reduction in CGT exemption and higher rates of CGT payable, it can be tempting to fall into the trap of trying to actively avoid taking action, for fear of the CGT consequences. Giving back 18% or 24% of the profit made in tax, whilst unpalatable, however, may be preferable to the potential cost of not taking action.
Consider the position of Mary, a higher-rate taxpayer, who holds a single investment worth £100,000, which has doubled in value from the original £50,000 cost of purchase. The investment has traditionally performed well, but has struggled over recent years, and Mary therefore contemplates selling the investment. If she goes ahead, this crystallises a gain of £50,000, which is £47,000 above Mary’s annual exemption of £3,000. As a higher rate taxpayer, Mary would pay CGT at a rate of 24%, leading to a CGT liability of £11,280.
Mary goes ahead with the sale and reinvests the net sale proceeds of £88,720 (£100,000 sale proceeds less CGT payable) into another investment fund with better prospects for outperformance. After four years, Mary reviews her decision and notes that the new fund has made a compound return of 9% per annum since disposal, whereas the fund Mary held previously has only produced compound returns of 4.5% per annum over the same period. Mary’s investment value now exceeds what her investment would have been worth, taking into account the CGT payable, and she is holding a fund showing improved returns which could potentially mean her decision to switch investments becomes even more valuable in years to come.
Other hidden dangers
The above is a simple example that demonstrates the need to look beyond the potential tax hit and consider the opportunity cost of avoiding a CGT liability. There are, however, other risks that inertia can bring. One risk that could be exacerbated by avoiding a CGT liability is that an investment grows disproportionately in size compared to other assets held, leading to excessive concentration risk. This is particularly true for single investment holdings, where investors are faced with the growing risk that a downturn in the particular market could have an even greater impact. By regularly reviewing an existing portfolio and taking decisions on a discretionary managed or advisory basis, you can keep a cap on unrealised gains and avoid this situation occurring.
An impartial perspective
When faced with investment decisions that could create a CGT liability, inertia could prevent you taking actions that could damage your financial wealth over the longer term. Reframing the tax liability as a tax on gains already made, and focusing on the potential benefits of redeploying funds, can be beneficial. Independent financial advice can prove hugely valuable in this regard, as the input of a skilled and experienced adviser can provide you with an impartial perspective on the best course of action to take. Speak to one of the team to start a conversation.
