Ian Thomas, Pilot Fiancial Planning
"Use it or Lose it"
It is difficult for a long-term investor in this country to outrun inflation by a significant margin, whatever he or she buys. Why? Because of Capital Gains Tax (CGT).
Let’s imagine that you purchase an investment property for £200,000. Over the next 10 years the value of the property increases by 4.5% each year, after allowing for maintenance costs, fees, etc. Inflation over the same period averages 3.5%.
After 10 years, the property is worth over £310,000; not a bad return you think (55%), so you sell it. Unfortunately, you also get a Capital Gains Tax bill. You’ll pay 18% or 28% over the annual allowance (currently £10,900). Assuming that the gain is taxed at the higher rate, the bill would amount to £28,000, leaving you with £282,000: an £82,000 profit.
But wait a minute. Due to inflation, in 2024 £282,000 has exactly the same purchasing power as £200,000 in 2014, so you’ve not really made any money at all!
The point? As CGT is no longer indexed to inflation (it was until 2008) it is now effectively a wealth tax. The more money you invest, the less help the annual CGT allowance is in protecting you from simply being taxed on inflation, rather than genuine capital growth, when you eventually sell. And the more inflation rises, the harder it will hit all UK investors.
As the financial year draws to a close on April 5th, it’s therefore worth checking that you have utilised any relevant allowances and reliefs to ensure that you do not pay more CGT (or indeed any other tax) than is necessary, now or in the future.
ISAs
This year it’s possible to shelter up to £11,520 in a ‘Stocks & Shares’ ISA – equal to more than £23,000 for a married couple - but if you miss the April deadline this rare gift from the Chancellor is lost forever. Over time, it’s quite possible to build up a substantial fund that grows tax efficiently and can be accessed at any time, with no income or capital gains tax payable.
Capital Gains Tax Annual Allowance
Aside from the longer-term growth potential, one of the advantages of an investment portfolio that invests in the stocks and shares (either directly, or through investment funds) is that some holdings can be sold each year to utilise your annual CGT allowance, rather than leaving any gains to accumulate and – as in the example above – be taxed heavily on the eventual sale. For example, a gain of £54,500 could be cleared completely over a 5 year period even if the annual exemption remains at £10,900. This could save around £15,000 for a higher rate taxpayer
Pensions
Pensions can also be highly efficient from a taxation perspective. Company owners, for example, are often well-advised to make pension contributions as part of an overall financial planning strategy. Any payments will reduce top-line profit (and transfer these pre-tax earnings into your own name), but also reduce your dependence on the eventual sale of the business to fund your retirement income.
All growth on pension fund assets is free of capital gains and income tax* which, as we’ve seen, is not an insignificant benefit for the long-term investor. Unfortunately, unlike the ISA allowance which generally goes up over time, the annual pensions allowance has fallen significantly since 2011, and is set to fall again in April. Is it worth considering increasing your funding now?
* Withholding tax on UK dividend income cannot be reclaimed.
If you’re interested in knowing more - why not give Ian Thomas a call on 01803 839 194? Alternatively, send him an email at ian@pilotfinancialplanning.co.uk. He’d love to hear from you!
www.pilotfinancialplanning.co.uk
Pilot Financial Planning is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.
First published By The Dart March 2014
