While investors will be hoping that 2023 proves more positive for stock markets than last year, the tax environment looks increasingly unfriendly.
A range of measures announced in November’s Autumn Statement (see table) threaten to increase tax bills from April and for years to come.
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The tightening tax squeeze*
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£12,570 tax-free personal allowance and £50,270 higher-rate income tax threshold frozen until 2028
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45% income tax threshold reduced from £150,000 to £125,140 from April 2023
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Dividend allowance reduced from £2,000 to £1,000 from April 2023, then to £500 from April 2024
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Capital gains tax allowance reduced from £12,300 to £6,000 from April 2023, then to £3,000 from April 2024
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Inheritance tax thresholds (£325,000 and £175,000 residential nil-rate band for property) frozen until 2028
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*Personal tax measures announced in the November 2022 Autumn Statement
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These come on top of other unwelcome tax moves in recent years — including the freezing of the pensions lifetime allowance (LTA) and an increase in dividend tax rates — which are already impacting investors.
So, what can you do to combat the latest tax squeeze?
Pensions, VCTs and EIS
With the income threshold for paying 40% tax frozen at £50,270 until 2028, another 2.5 million people are expected to be drawn into this higher-rate tax band as salaries rise over the next five years. Meanwhile, many existing higher-rate taxpayers face paying 40% tax on a bigger slice of their incomes.
Likewise, with 45% tax kicking in at the reduced level of £125,140, more high earners will become subject to this top tax rate, while those already paying the 45% rate will see it extend to more of their income.
The good news is there are ways to reduce these higher tax bills. By paying into a pension, high earners can receive tax relief worth 40% or even 45% of their contributions. That said, this relief is subject to certain limits and there is ongoing speculation of further cuts (see Will the squeeze get even worse? below).
Other tax-saving options include investing in Venture Capital Trusts (VCTs) or the Enterprise Investment Scheme (EIS), which both offer 30% tax relief.
These could be particularly worth considering if you’ve claimed all the pension tax relief you’re entitled to, or are concerned about breaching the pensions’ LTA (which could lead to additional tax charges).
ISAs
With the tax-free allowance on dividends halving to £1,000 in April and to £500 in 2024, and that on capital gains cut from £12,300 to £6,000 in April (then to £3,000 from 2024), many investors could face higher tax bills on shares and funds that aren’t sheltered in ISAs or pensions.
This underlines the value of investing through an Individual Savings Account and of using your £20,000 ISA allowance each year. Currently, all ISA income and profits are tax-free, regardless of the size of your ISA portfolio.
Moving unsheltered shares and funds into an ISA to protect future returns from tax is also worth considering. This process, known as “bed and ISA”, involves selling the shares or funds and then buying them back within the ISA.
Use your £12,300 CGT allowance
The reduction in the annual capital gains tax (CGT) allowance from April to £6,000 (and to £3,000 from 2024) means it could be worth realising investment gains now to make use of the current £12,300 allowance.
Investors with larger gains should also consider whether they have any investment losses that could be offset against profits to avoid or reduce a CGT bill.
Alternatively, by reinvesting taxable gains in an EIS scheme they can defer their CGT liability, potentially enabling those gains to be spread across several year’s CGT allowances to escape tax altogether.
Consider transfers to your spouse
With tax allowances for individuals squeezed, couples may also be able to save tax by transferring investments to whichever partner has unused allowances or who is in a lower tax band.
Importantly, for married couples and civil partners these transfers can be made without triggering a tax bill.
Gifting to reduce IHT exposure
The freezing of inheritance tax (IHT) thresholds until 2028 means that increasing numbers of families are likely to be caught by this 40% levy.
The threat of a substantial IHT bill highlights the importance of individuals planning ahead and considering various options for reducing their wealth while they are alive, whether by spending or giving away money and assets.
Several IHT-free allowances are available, including a £3,000 annual gift exemption.
However, you may need to live seven years after making larger gifts for their value to escape the IHT net.
Will the squeeze get even worse?
The continuing strain on the public finances means more government tax grabs cannot be ruled out.
There has been much talk in the media about the cost of pension tax relief and how it disproportionately benefits the wealthy. Among the possible changes might be reducing the rate of tax relief for higher earners, or lowering the annual allowance for contributions from £40,000 to £20,000.
There has even been some speculation about a possible tax clampdown on ISAs, potentially by capping total contributions or limiting the overall value of investments that can be accumulated tax-free.
The government has announced that its Spring Budget will be on 15 March 2023. And while there has been no indication yet that it will include further tax pain for investors, it’s also unlikely the Chancellor is planning a tax giveaway.