It is sometimes possible to sometimes have too much of a good thing. This is certainly true for any capital gains that may have accumulated, but have not been crystallised in your investment portfolio.
Although it’s generally good news that your investments and wealth are increasing in value. The flip side of the argument is that the taxman will at some point have any tax that is due. If your taxable investment gains are left to simply accumulate, so too is the likelihood that under the capital gains tax rules, a day will come when you need to encash a sizeable portion of your taxable portfolio.
Fortunately, there is a tax planning process we can use to your advantage as part of your annual financial planning. By taking profits on an annual basis we can improve the financial position of your investment portfolio by using your annual CGT allowance to take capital gains (CGT) out of your portfolio.
How do we do this?
Each tax year, you and if you are married, your spouse have the option to crystallise an amount of any gains you might make without incurring any liability to capital gains tax. For the tax year 2016/2017 the annual allowance is a maximum of £11,100. This amount is per person so you and your spouse can transfer assets between both of you to obtain the total taxable allowances of £22,200 of gains each year, per couple.
This means depending on your financial situation that it could be in your interest to take any gain each year up to and including maximum allowable amount. Doing this is called bed and breakfasting. There is a 3-step process to do this. The steps are:
- Sell some or all your investment holdings in your portfolio when they are worth more than you paid for them. This will crystallise the gain (with no tax liability).
- Hold the investment proceeds in cash for at least 30 days. This is an HMRC requirement.
- Reinvest the cash proceeds into the original investment(s) no earlier than 31 days later.
As you might expect, there are certain things you should consider when using the capital gains tax rules. If you do crystallise any capital gains, it’s important that you consider your long-term investment objectives and stick to your financial plan. Rather than continually buying and selling assets it is better to stay in the market for as long as possible to achieve growth on your investments.
It is not sensible to sell down all capital gains proportionally across your various investment holdings (within the allowance threshold) as this method is often inefficient. This method may remove far too much cash from your portfolio that will be held in cash for more than 30 days, whilst increasing trading and stamp duty costs within the portfolio. We would normally recommend that you sell as few holdings in your portfolio as possible.
Our aim is to achieve an appropriate balance between the available tax benefits and staying on course as far as your financial plan is concerned. It’s usually a good idea to prioritise selling down the investment holdings that have the greatest percentage of gains. This will enable us to place the fewest trades, resulting in lower overall trading costs and thus holding less cash.
There are also other ways to minimise the amount of time any gains sit in cash and remain out of the market. One way is to buy similar but not identical assets and to hold them instead of the original investments.
If you are married, there might be the possibility to sell investment funds held in one partner’s name, then to gift without tax implications the proceeds of the sale to the other spouse. Your spouse could then repurchase the same assets in his or her name. After a reasonable period, i.e. more than 30 days you could then transfer the assets back to the original partner’s name.
We usually hold off on capital gains tax planning towards the end of the tax year so we can combine the planning into the rest of your tax – and financial-planning tasks (e.g. funding your Pensions and ISAs).
The benefits of using CGT allowances
Over the long term, gains or growth that has accumulated in your taxable accounts is an integral part of your financial journey towards accumulating wealth. As gains occur, we can often soften the tax-burden blow by making use of the annual tax allowance on crystallised gains. This is just one aspect of the ongoing service we can offer you. We do not offer aggressive tax planning strategies and the Inland Revenue now have the ability to challenge such schemes
Deciding when and how to put into place appropriate tax planning strategies is one way we can add value and improve the overall return you get from your investments. If you have any questions of just want to discuss your own personal situation, then please feel free to contact us.