As the Chancellor prepares to unveil her first Budget on 30 October 2024, there is growing speculation that she may align Capital Gains Tax (CGT) rates with income tax. This comes after recent cuts to the CGT annual exemption and dividend allowance, refocusing attention on the choice between bonds and collective investments such as Open-Ended Investment Companies (OEICs) and unit trusts.
For retail investors, it’s critical to understand how this potential tax change could affect investment returns and the choice of tax-efficient wrappers. More importantly, before making any significant decisions, seeking professional financial advice is essential to ensure your investments are well-positioned to maximize potential benefits while mitigating tax liabilities.
Current Tax Rates and the Impact of Alignment
At present, gains from collectives are taxed at 10% or 20%, depending on your income tax bracket, while dividends are taxed at 8.75%, 33.75%, or 39.35%. In contrast, bond gains are subject to income tax rates—20%, 40%, or 45%.
If CGT is aligned with income tax, the difference between bonds and collectives will narrow. However, equity-based collectives could retain an advantage due to lower taxation on dividends.
That said, it’s important to note that recent cuts to allowances—the CGT exemption reduced to £3,000 and the dividend allowance to £500—have made bonds more competitive. Offshore bonds, in particular, benefit from unique tax allowances such as personal savings allowances and top-slicing relief, which can significantly reduce the tax payable on bond gains.
The Importance of Tax Planning
The tax implications for bonds and collectives differ substantially, so it’s crucial to consider how each product is taxed over the investment period.
- Collectives: Investors in collectives are subject to capital gains tax on disposals and income tax on dividends as they arise, regardless of whether they are reinvested. This limits the ability to control when tax is due.
- Bonds: Offshore bonds benefit from ‘gross roll-up,’ meaning gains are only taxed when funds are withdrawn. This offers more control over when tax is paid. If structured properly, an investor could withdraw funds tax-free by using personal allowances and reliefs—especially in years with no other income.
Flexibility in Retirement and Tax-Efficient Withdrawals
Offshore bonds provide retirees and those with fluctuating incomes flexibility to control when they realize gains. For instance, a retiree with little or no income in a given year could withdraw up to £42,000 tax-free by keeping gains below £18,570, benefiting from personal allowances and top-slicing relief.
This flexibility could be particularly useful for those in retirement, where bond gains can be used as a bridge before accessing pensions, or to fund children’s education when they have little or no income. These strategies aren’t available for onshore bonds, which suffer tax on gains even if the investor is a non-taxpayer.
Other Considerations Beyond Taxation
Tax is just one part of the equation. Other factors such as gifting, investment losses, and the treatment of investments on death also influence the choice between bonds and collectives.
- Gifting: Offshore bonds can be easily assigned to another person, including children, without triggering an immediate tax charge, whereas gifting collectives may incur CGT.
- Losses: Investment losses on collectives can be offset against gains, but losses on bonds cannot be set off in the same way.
- Death: Gains on collectives are wiped out upon death, with beneficiaries inheriting investments at their market value. Bonds, however, retain their tax liabilities.
The Role of Financial Advice
In light of these complexities, the decision between bonds and collectives will depend heavily on your personal circumstances and long-term financial goals. Aligning CGT with income tax may change the balance between the two, but each has unique benefits that can be maximized with careful planning.
Given the potential for future changes to legislation, many investors may benefit from holding a combination of both bonds and collectives. This diversified approach could offer flexibility, allowing you to optimize tax efficiency and hedge against potential future tax changes.
Before making any major investment decisions, especially in light of these potential changes, it’s strongly recommended to seek financial advice. A professional advisor can help tailor your investment strategy to your unique situation, ensuring that you make the most of the tax benefits available while aligning with your long-term financial goals.
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Any reference to legislation and tax is based on our understanding of United Kingdom law and HM Revenue & Customs practice at the date of production. These may be subject to change in the future. Tax rates and reliefs may be altered. The value of tax reliefs to the investor depends on their financial circumstances. No guarantees are given regarding the effectiveness of any arrangements entered into on the basis of these comments.