New tax rules and higher taxes – what are the options for experienced investors?
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
UK taxpayers face the highest peacetime tax burden.
The latest HMRC figures show receipts from April 2022 to April 2023 for income and capital gains tax, together with National Insurance contributions, reached £440.9 billion – a substantial increase of £47 billion over the previous tax year. In the same period, inheritance tax receipts reached a record £7.1 billion: up £1 billion year-on-year.
And the trend appears set to continue as a result of the tax rule changes that came into force this April.
So, if you are an experienced investor, how might you cut your tax bill – whilst supporting young and growing British businesses? What steps could you take today?
Here we look at what the new rules are and what you could do to mitigate the impact.
Tax benefits depend on circumstances and tax rules can change. This is a brief outline based on current rules: there are detailed conditions and rules you should consider carefully before investing. There are limits to the amount which can be invested into some of these investments each tax year and minimum holding periods to retain tax reliefs may apply. Decisions should be based on the investment merit, not the tax reliefs alone.
What changes have taken effect from 6 April 2023?
- Income tax: higher earners to pay more — How to reduce your income tax bill with up to 50% income tax relief?
- Tax on dividends: tax-free allowance halved — How to get tax-free dividends?
- Capital gains tax (CGT): tax-free allowance halved — How to minimise a CGT bill?
- Inheritance tax: thresholds frozen until 2028 — How to minimise the impact of inheritance tax?
Income tax: higher earners to pay more
The threshold at which you start paying the top rate (45%) of income tax has dropped from £150,000 to £125,140. More taxpayers will be caught. Meanwhile, existing top-rate taxpayers will see an average increase of £1,200 on their income tax bill.
Personal allowance and income tax thresholds: frozen until 2028
The personal allowance of £12,570 will remain frozen until 2028 – and so are the income tax thresholds. This, combined with wage inflation, means a larger portion of incomes will be taxed, and some people will fall into higher tax brackets.
By 2028, HMRC forecasts 1,130,000 more people will pay higher-rate tax, while 301,000 more will become top-rate taxpayers.
How to reduce your income tax bill – up to 50% income tax relief
Pensions have historically been the go-to investment to reduce one’s income tax bill. Successive restrictions over the last 13 years mean this is no longer an option for many. For high earners, the allowances can be much less generous.
An increasingly popular alternative is to invest in British startups through VCTs, EIS and SEIS. To mitigate the high risks involved, the government offers valuable tax reliefs:
- VCTs: save up to 30% on this year’s income tax bill. You can invest up to £200k per tax year. Read more and see current VCT offers »
- EIS: save up to 30% on this year’s income tax bill and/or potentially get back tax you’ve already paid last tax year. You can invest up to £2 million (if including knowledge-intensive EIS) per tax year. Read more and see current EIS offers »
- SEIS: save up to 50% on this year’s income tax bill and/or potentially get back tax you’ve already paid last tax year. You can invest up to £100k per tax year (limits are rising in 2023/24). Read more and see current SEIS offers »
Dividends: tax-free allowance halved
The annual dividend allowance – the amount you can receive before having to pay tax – has halved from £2,000 to £1,000 and will halve again to just £500 from 6 April 2024. Once you use the allowance, you pay tax on dividends based on your income tax band. So if you’re pushed into a higher income tax band, you will pay more tax not only on your income but likely also on any dividends you receive.
How to get tax-free dividends
Dividends are normally tax free if the investment is held in an ISA, so investors could consider making full use of the yearly £20,000 ISA allowance.
In addition, you could consider investing in VCTs.
Tax-free dividends with VCTs: any dividends they pay should be tax free. This could be of significant value: if a VCT pays a 5% dividend, that means you get 5p for every £1. To match that, assuming the dividend allowance has already been used, a higher-rate taxpayer would have to receive a taxable dividend of 7.55% (8.24% for a top-rate taxpayer).
Capital gains tax (CGT): tax-free allowance halved
This is perhaps the most punitive change. The capital gains tax-free annual allowance has been cut from £12,300 to £6,000, and will be cut again to £3,000 from April 2024, reaching the lowest level since 1981.
How to minimise a CGT bill
Once again, ISAs could help as any gains from investments held in an ISA should be tax-free. Other strategies include crystallising losses within the annual allowance or in some cases transferring assets to a spouse.
Defer gains with EIS: when you invest a gain (or part of a gain) in EIS, you should be able to defer the tax on the proportion of the gain invested for as long as the money stays invested – potentially indefinitely. The tax should only become payable when you realise your EIS investment, unless you roll that into another EIS investment. You could defer gains realised up to one year before and three years after your EIS investment date. You can invest up to £2 million (if including knowledge-intensive EIS) per tax year.
Cut a CGT tax bill in half with SEIS: when you invest a gain (or part of a gain) in SEIS, you could reduce a CGT bill by up to 50%. You could use the relief on investments in the tax year of your investment or the year before. To benefit, you must have had the income tax relief for the same year. You can invest up to £200,000 per tax year .
Inheritance tax (IHT): thresholds frozen until 2028
The inheritance tax nil-rate band – the value of your estate which should be free from inheritance tax – will remain frozen at £325,000 until April 2028. Since the inheritance tax nil-rate band last changed in April 2009, UK house prices have reportedly gone up by an average of 72.13% (December 2022).
The residence nil-rate band will also be frozen at £175,000 and the residence nil-rate band taper will be frozen at £2 million until 2028. Meanwhile, the latest figures show HMRC raised a record £7.1 billion in IHT receipts in the year to March 2023: £1 billion more than the previous year.
How to minimise the impact of inheritance tax
There are many established ways to mitigate inheritance tax – we cover the main ones in our free guide.
A particularly relevant one for experienced investors is investing in AIM Inheritance Tax ISAs – professionally managed portfolios of AIM shares designed to be eligible for IHT relief if held for two years and on death. You can transfer unlimited amounts from existing ISAs or use your ISA allowance – currently £20,000 per individual per tax year.
There is nearly £700 billion held in adult ISAs, according to the latest figures (2020/21). Eventually, some of that money might be eaten up by tax because ISAs are normally income and capital gains tax free – but not IHT free.
IHT of up to 40% could apply when a person’s total assets, including their main home, exceed £500k (£1 million for married couples / civil partners). So, ISAs could eventually be subject to a tax charge on death.
If IHT is a concern and you have ISAs from previous years or are planning to make an ISA subscription, transferring or subscribing to an AIM Inheritance Tax ISA could be a consideration.
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