Three taxes you need to know about if you’re an investor
By Boring Money
29 April, 2024
Have you ever wondered how tax applies to your investments? UK tax law is pretty complicated and it can be a headache trying to understand the rules, reliefs and allowances - especially in relation to additional income such as investing. But don’t fret! We’re here to simplify things and explain the three main types of tax that UK investors should be aware of, including how to know if you qualify and how much each one could cost you.
Capital Gains Tax
Capital Gains Tax (often abbreviated to ‘CGT’) is a tax that you pay to the UK government on the profit - “gains” - you make when you sell something - an “asset” - that has increased in value from when you bought it. Most of the time, this refers to things like shares, bonds, property and other investments. So if you’re an investor, CGT should be on your radar.
If you’re investing with an account which is not tax-efficient (i.e. not an ISA), you might have to pay CGT on your total gains that exceed the tax-free allowance. So this includes anyone investing with a General Investment Account (GIA), for example, which is not shielded from tax like an ISA is.
The tax-free allowance on capital gains for the 2024-25 tax year is £3,000 for individuals and £1,500 for trusts. This has been significantly lowered in recent years. In fact, it’s now less than a quarter of what it was in the 2022-23 tax year, when the tax-free allowance for individuals was a decidedly more generous £12,300.
We asked Chartered Financial Planner Lena Patel to explain why Capital Gains Tax matters when you’re investing and some ways to reduce how much you need to pay.
Capital Gains Tax and the annual allowance is often overlooked when assessing the benefits of investing - particularly when looking at property investments versus investing in funds and wrappers, for example collective investment accounts.
By monitoring your gains and being mindful of the allowance, which is currently £3,000 for the 2024-25 tax year, you can potentially structure your asset sales strategically to utilise the exemption fully. In addition, it’s best practice to keep regular updated records of transactions, including purchase and sales dates, costs and any allowable deductions. Accurate record-keeping can help ensure you accurately calculate your tax liability.
If you’re considering investing, an ideal way of managing CGT would be to invest regularly in an ISA. The benefits of this would mean any gains made on the funds invested within the ISA wrapper would be free of Capital Gains Tax and any income received from the ISA would also be free of Income Tax.
You can read our essential guide to Capital Gains Tax here.
Income Tax
Income Tax is a tax that you pay to the UK government on your earnings or profits (your taxable ‘income’) if they exceed the annual Personal Allowance. The Personal Allowance for the 2024-25 tax year is £12,570. This means that if you earn over this amount, you need to pay Income Tax.
Most employed or self-employed adults in the UK have to pay Income Tax, but you may be more likely to if you’re receiving interest or dividends from investments, as this will contribute to driving your taxable income over the Personal Allowance threshold. This is because Income Tax applies to investment interest, such as that from savings accounts, share dividends and peer-to-peer lending that is not shielded in a tax-free account like an ISA.
We asked Financial Coach and Chartered Financial Planner Graham Wells to explain why Income Tax is important to investors.
The good thing about Income Tax from an investing perspective is that it’s largely avoidable for the vast majority of UK residents. The key is to create solid financial habits, making good use of the annual ISA and pension contribution allowances. Generally speaking, investment returns in both these types of product are free from Income Tax (and Capital Gains Tax) and profits don’t even need to be declared on tax returns.
So if you do your investing through an ISA, you won’t have to worry about Income Tax on any of your gains. However, Graham warns not to forget that your pension won’t be exempt from Income Tax forever – it's just putting off the tax bill until later.
Contributions into a pension have the effect of reducing the Income Tax you pay right now, but remember that when you start to take money out of a pension, only 25% is tax-free. After that, withdrawals are subject to Income Tax at your highest rate. Therefore for many people, a combination of ISAs and pensions provides the best of both worlds.
Graham’s top tip for investors is “to begin making use of these allowances as soon as possible and start investing early. The compounding effect of tax efficiency over many years can be worth thousands to your future self.”
For those investing larger amounts and with higher appetites for risk, other tax-efficient options are available, such as Venture Capital Trusts and Enterprise Investment Schemes. These can offer attractive tax benefits, but also carry additional risks and complexities, so regulated financial advice would be well worth considering in these cases.
You can read more in our essential guide to Income Tax here.
Dividend Tax
If you receive dividends from your investments, you may have to pay tax on this income, but only if it exceeds your annual dividend allowance. However once again, if you’re investing through an ISA, you don’t have to pay any tax – no matter how much you make in dividends. Another compelling reason to consider an ISA if you haven’t already!
The annual dividend allowance for the 2024-25 tax year is just £500. This has fallen significantly in recent years from £2,000, so more investors are likely to get caught out with dividend tax now that the rules have changed.
If your dividend income (outside of a tax-exempt account like an ISA) is more than the £500 annual allowance, you will have to pay tax, the rate of which is calculated based on your usual Income Tax band. The table below shows you how much you could pay:
Income Tax band | Tax rate on dividends over annual allowance |
Basic rate | 8.75% |
Higher rate | 33.75% |
Additional rate | 39.35% |
We asked Life Planner and Financial Coach Adrian Kidd to explain how investors could get caught out by dividend tax and how you can reduce your chances of this happening.
Number one - if the recent changes to dividend tax legislation affect you, consider yourself fortunate! Why? Well, your investing strategy should be that you’re maximising your pension and ISA allowances first. This can mean you’re saving something like £80k a year. That’s a lot of money and largely out of the scope of most folks.
Dividends are paid (and taxed) on what we call ‘unwrapped’ investment accounts. These could be individual shares that you hold or equity funds in a General Investment Account (GIA), for example. So dividend tax usually only applies if you’re investing outside of an ISA or pension or you’ve already maxed out your allowances for the year.
Whilst dividends are nice to get and form part of the total return of an equity, they do sit at the top of the tree when it comes to working out taxes due to HMRC (after income, property income, etc), so they get taxed at your highest rate. As the dividend allowance has been cut down to £500, it only requires a £25,000 unwrapped holding, paying 2%, to get you to the allowance threshold!
So how can you limit dividend tax on your savings or investments? If your only income is from investments, your tax-free personal allowance can be used before you start paying tax on your dividends. This is in addition to the £500 dividend allowance.
You can also look to transfer shares and funds to your spouse (where no capital gains are due currently) to maximise two dividend allowances. And if your spouse pays a lower rate of tax than you, this will reduce your tax bill further still. If you’re sitting on capital losses, you could sell the shares and reinvest the proceeds into ISAs, pensions or even an investment bond.
As always with these types of things, it pays to get advice personalised to your whole situation and not look at this one part in isolation.
