Investment taxes loom large

David Prosser looks at how to make the most of tax-free savings allowances.

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January is traditionally the time of year when we focus on our tax affairs. Millions of Britons covered by the self-assessment tax system must file their 2022-23 tax year returns by the end of the month. And the countdown to the end of the current 2023-24 tax year on 5 April is now well underway – that means time is running out to make full use of annual savings allowances such as individual savings accounts (ISAs).

Remember, the annual ISA allowance, which you can use to invest in a hugely varied range of assets – including funds from across the investment companies sector – is worth £20,000 each tax year. Crucially, there is no tax at all to pay on income or profits earned on investments held inside an Isa; they don’t even have to be declared on your tax return.

“Crucially, there is no tax at all to pay on income or profits earned on investments held inside an Isa; they don’t even have to be declared on your tax return.”

David Prosser

David Prosser

These exemptions are becoming more valuable because the tax system is getting tougher. As the government seeks to repair the public finances, taxes on investments are effectively increasing.

If you’ve just completed your tax return for 2022-23 you may have been able to take advantage of two allowances that reduce or eliminate your tax bill on investments held outside an ISA. In 2022-23, you were entitled to earn £2,000 of dividends on assets such as investment company shares before you had to pay any income tax on the money. And you were also entitled to cash in investment profits of up to £12,300 without having to worry about capital gains tax (CGT).

For 2023-24, however, these exemptions are much lower. First, the dividend allowance has come down to £1,000. And second, the CGT allowance now stands at just £6,000. Even worse, on 6 April, the first day of the 2024-25 tax year, the screw is set to tightens once again. The dividend allowance will fall to £500 and the CGT allowance comes down to £3,000. These levels will then be frozen over the years ahead.

In practice, this means that many more people will find themselves dragged into the tax net because of the income and profit generated by their investments. Using your ISA allowance therefore makes more sense than ever. It may even be a good idea to think about selling assets you currently hold outside an ISA and then buying them back within the shelter; this will carry transaction costs and you must be careful not to trigger a tax liability, but it could save tax in the long run.

Investment company shareholders need to consider these issues particularly carefully. For one thing, many investment companies have an excellent track record of generating rising dividend income; indeed, this is what has attracted many investors to the sector. In which case, do all you can to protect that income from tax in the years ahead.

Moreover, the long-term capital performance of investment companies has been impressive – in most sectors, the average investment company has outperformed other types of collective funds investing in similar assets, especially over extended periods. Again, mitigating your tax liability on the potential gains of the future is very important.

Remember, you don’t have to use your entire £20,000 ISA allowance in one go. You can drip feed money into funds with regular monthly payments – this is an affordable way to use as much of your ISA allowance as possible