How to protect your portfolio from IHT and CGT after the budget

The new Labour Chancellor has launched a tax raid on investors and business owners that threatens to curtail the entrepreneurial spirit that drives our economy.

Capital gains tax, inheritance tax, and National Insurance were all targeted this week with freezes on thresholds or eye-watering increases. 

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Most investors’ main concerns will be the increase in capital gains tax, the shakeup of inheritance tax relief for AIM shares, and bringing pensions under inheritance tax.

However, while the tax changes will be a kick in the teeth, savvy investors still have various options to protect their savings from the tax man. 

ISAs & SIPPs

An obvious place to start is using your ISA and Pensions allowances to protect your investments against capital gains tax. Investors have an ISA allowance of up to £20,000 and can put upto 100% of their income or a maximum of £60,000 into a a SIPP each year.

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Thankfully, these were left unchanged by the chancellor. Ideally, these would have been increased to boost investment and sensible savings, but this wasn’t a budget for investors.

“The tax relief afforded to pensions and ISAs has survived the Budget, with the exception of the generous tax treatment of pensions on death. In particular, investments held within pensions and ISAs aren’t subject to capital gains tax, nor are the dividends they produce subject to income tax,” said Laith Khalaf, head of investment analysis at AJ Bell.

“A rise in capital gains tax, especially combined with an annual CGT allowance of just £3,000, means investors should prioritise pensions and ISAs if they’re hoping for growth on their investments.”

Khalaf continued to explain the tactics of ‘Bed and ISA’ or ‘Bed and SIPP’, which can bring investments into your tax wrappers to protect them from future capital gains tax.

“Those who hold unwrapped investments can perform a manoeuvre called a ‘Bed and ISA’ or ‘Bed and SIPP’ to move them inside a tax shelter. This does involve selling assets so there is potentially a capital gains tax liability at this point, though investors can mitigate this by judicious use of their annual £3,000 CGT allowance,” said

“Once inside the SIPP or ISA, any further gains are then free from tax. Investors who feel they might breach the £3,000 annual CGT allowance using this approach might consider pairing the sale of a profitable investment with a loss-making one. Losses can be used to offset gains, thereby reducing the capital gains tax liability, then either or both investments can be rebought within the ISA to avoid tax on future gains.”

Unfortunately, Pensions will now be included in individuals’ estates for IHT purposes, so those seeking to protect their portfolio on their death must consider alternative assets.

EIS & VCTs

More experienced investors with longer time horizons may want to consider VCTs and EIS. The schemes have generous tax benefits for investing in early-stage companies but come with much higher risks than listed equities.

The chancellor announced the schemes will be extended until 2035, signalling much needed certainty for investors using the schemes to shelter their investments from IHT and EIS.

“At a headline level Venture Capital Trusts have been left unaffected by this Budget. Investors will still receive upfront income tax relief of up to 30%, plus tax free dividends and capital gains tax (CGT) free growth,” said Nicholas Hyett, Investment Manager at Wealth Club.

“However, in relative terms the scheme has become significantly more attractive. With income tax thresholds frozen for years to come and CGT rising, the potential for tax free returns have become even more appealing.”

EIS provides investors with complete relief from income tax, CGT and IHT if unlisted shares are held for more than three years. However, the budget did cap the level of investments that are free from IHT to an allowance of £1 million in the budget.

“As shares in unlisted businesses, EIS qualifying investments qualify for Business Relief (BR). In the past this meant any amount of EIS investments could be passed on inheritance tax (IHT) free. Going forward investors could face a 20% IHT bill of EIS investments if they already have £1 million of BR qualifying investments,” Hyett explained.

“However, for individual investors, EIS has probably jumped up the list of investments worth considering. CGT free growth is more attractive now, and CGT deferral is more valuable in a higher tax world. Throw in 30% up front income tax relief and wealthy, sophisticated investors should certainly spend some time exploring the area. If the budget sparks significant inflows that would also be good news for British start-ups – potentially unlocking significant funding at lower cost.”

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