My investment pot has swelled to £46,100 in eight years
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I’ve been making regular monthly investment contributions and reinvesting the dividend.
I have paid £300 in each month for the past 97 months, and in doing so have accumulated £46,100 from a total investment of £29,100 plus the dividends that I have reinvested.
How can I calculate capital gains tax on this investment, and have I dug myself into a tax trap?
What options are open to me to reduce my future capital gains tax bill? R.B via email
Harvey Dorset of This is Money replies: Committing to a long term investment, and sticking to those monthly contributions, is no mean feat.
In your case, the pay off has been that your investment has steadily grown considerably beyond what you have invested yourself.
What this means, however, is that you’ll likely face a hefty capital gains bill when you come to selling these investments.
Even so, there are ways in which you can cut down your eventual tax bill when you look to dispose of your investments in the future.
To a certain level, you will no pay tax on the gains you have made. This comes in the form of the annual allowance, which, just last week was reduced to £3,000 from £6,000 for the new tax year.
On top of this, you are entitled to a dividend allowance of £500 for the new year from April.
Going forward, there are also a variety of ways in which you can lower your capital gains tax charge, or make the most effective use of your monthly investment contributions.
These options include making a gift to your spouse, capitalising on the benefits of Isas and gradually disposing of your investments using your annual allowance.
I asked two experts for their advice on what you can do reduce your capital gains bill, and make the most out of your investments in the future.
Toby Tallon, tax Partner at Evelyn Partners, replies: Congratulations on setting aside a regular sum for so long.
I can empathise with the tax headache, having been in a (much more modest) position when cashing in 10+ years’ worth of accumulation fund units.
Happily, you have many tools to spring the tax trap.
I will contemplate your tax position in my response but not any investment considerations.
Calculating the gain
The base cost of your investment is the total of:
· Monthly contributions. You already calculated these as £29,100 (£300 for 97 months); and
· Reinvested dividends. Either check through 8 years’ worth of statements (easier approach if you have access to them) or use a spreadsheet to add in the appropriate accumulated shares from each dividend (more time-consuming).
All shares in the same asset are pooled together for base cost purposes, assuming no shares in the same asset are repurchased within 30 days of a sale.
The proceeds on a sale are matched to the total base cost in proportion to the number of shares sold. For example, if you owned 500 shares and sold 100, the base cost for these 100 shares would be 100/500 of the total base cost.
Reducing the pain
1) Annual exemption
· The Capital Gains Tax (CGT) annual exemption was £6,000 for 2023/24, reducing to £3,000 for 2024/25.
· This is a ‘lose or use it’ exemption that could be used over multiple tax years.
2) Capital losses
· Any capital losses realised on other assets can be set against capital gains realised in the same tax year or rolled forward to future tax years.
· Any other investments sitting at a loss could be realised to be offset against the gain.
3) Gift to spouse
· If you are married / in a civil partnership, consider gifting shares to your spouse for them to make use of their annual exemption or capital losses.
· Shares gifted to a spouse / civil partner take place at ‘nil gain nil loss’, meaning no capital gain for the transferor and the transferee spouse takes on the base cost.
4) CGT rate
· CGT is 10 per cent on any gains that fit within your remaining income tax basic rate threshold.
· CGT increases to 20 per cent once you are a higher rate tax payer.
5) EIS / SEIS investments
· Investments in certain EIS / SEIS qualifying companies carry potential capital gains tax deferrals / exemptions (amongst other tax benefits).
· Such investments carry a significant investment risk, and specialist advice is recommended.
Further pain?
There may be a further tax issue to consider. Although the dividends were automatically reinvested, they are still considered income.
However, hopefully the dividends were covered by your annual allowances:
· Personal allowance. Offset first against earnings and other savings income, anything left could be set off against dividend income. Worth £11,000 in 2016/17, rising to £12,570 by 2021/22.
· Dividend allowance. Specific dividends allowance worth £5,000 in 2016/17 and 2017/18, £2,000 from 2018/19 to 2022/23, £1,000 in 2023/24 and £500 in 2024/25.
Any dividends in excess of the above allowances should have been taxed at rates of up to 39.35 per cent, depending on your overall income and the tax year.
Never again
There are some points that you may wish to consider next time round.
Isas
· Investing via Isas avoids complexity and tax costs. I assume these shares are not in an Isa.
· All interest, dividends, and capital gains arising within an Isa are tax-free.
Pension
· Contributing to a pension would enable all income and capital gains to roll up tax free within the pension wrapper.
· Tax can apply on withdrawals after an individual is at a pensionable age (currently 55, rising to 57 from 2028).
· Pensions rules are complex and specialist advice is recommended.
Liviu Ratoi, independent financial adviser at Flying Colours replies: To calculate your capital gains tax, you’ll first need to determine the total gain made by taking the current value and subtracting the original investment.
In this instance, the calculation is: £46,100 (current value) minus £29,100 (the ‘book’ cost of £300 per month for 97 months), which equals £17,000.
Since you’ve reinvested the dividends received over the period, you’ll need to account for these in your overall gain.
When dividends are reinvested, they increase the original book cost, which therefore reduces your gain when you eventually sell the investment.
To determine your revised book cost after reinvesting the dividends, you would need to track each reinvestment and add it to your original book cost of £29,100.
Once you’ve calculated the total gain, you can work out the CGT. Currently, CGT is applied at different rates depending on your total income and gains across the tax year. For the 2023/2024 tax year, the rates are as follows:
· Basic Rate taxpayers: 10 per cent on gains over the tax-free allowance up to the basic rate income tax band (£50,270 for the tax year 2023/2024).
· Higher Rate and Additional Rate taxpayers: 20 per cent on gains over the tax-free allowance.
As a UK resident, you will also have an annual tax-free allowance, known as the ‘Annual Exempt Amount’ for capital gains.
For the 2023/24 financial year, this is £6,000 or £12,000 for investments held jointly, reducing to £3,000 and £6,000 respectively for the 2024/25 financial year.
Whether you’ve dug yourself into a tax trap depends on your individual circumstances.
If the total gain doesn’t exceed your annual tax-free allowance, then you have nothing to worry about.
However, if your total gain exceeds your annual allowance then you’ll need to pay tax on the portion above the allowance at your marginal rate of tax.
If your annual income is close to £50,270 and the gain exceeds your annual allowance, then it’s likely part of the gain will end up being taxed at 10 per cent (basic rate) and part at 20 per cent (higher rate).
This is because capital gains is added on top of your income for the tax year to determine your overall position and therefore which rate of tax applies.
In term of reducing your future capital gains tax bill, you may want to consider some of the following options:
1. Utilise tax-efficient products: Consider investing through Isas or Pensions where gains are tax-free or tax-deferred.
2. Make use of your annual tax-free allowance: Each year, you have a tax-free allowance for capital gains. Make sure to use this efficiently by spreading your gains over multiple tax years where possible.
3. Offset capital losses: If you have any capital losses from other investments, you can offset these against your gains, reducing your overall tax liability. It’s important to note that these losses need to be registered with HMRC within 4 years of them arising and can be carried forward indefinitely.
4. Gift assets: Consider gifting assets to your spouse or family members who may be on a lower tax band and have them cash in the assets, effectively reducing the tax liability.
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