Where to save?
There are many non-tax factors that will need to be considered but putting these to one side and just focusing on the tax-planning aspects, it is the availability of reliefs and allowances that will generally determine the best place to save.
Fund taxation
Investment returns across all tax wrappers will be unchanged – equity investments will still pay out the same amount of dividend and funds have for many years been unable to reclaim the notional tax credit.
Mutual funds and offshore bonds
The new dividend allowance makes a compelling argument for building a collective portfolio where income and gains can be managed within the respective allowances. This can be achieved by keeping dividend income to below £5,000 per annum, and realising capital gains annually from their portfolio within the annual capital gains tax (CGT) exemption (£11,100 for 2015/16).
The portfolio value at which no tax will be due will depend on performance, but they could look something like this if allowances are fully used (see table opposite).
Of course, any re-allocation of assets to achieve income and gains at these levels would also have to be appropriate to the risk profile of the investor.
Excess dividends
Where fund values produce a dividend in excess of the allowance, and capital growth cannot be managed out annually using the annual CGT exemption, the choice becomes more difficult. And this can often be the case where funds are being actively managed and portfolios being regularly rebalanced.
Offshore bonds can protect the excess dividends from an immediate tax charge as they arise, because they defer the tax charge until surrenders are taken. Bonds roll up dividend income within the fund that will eventually be taxed under the chargeable event legislation and converted from dividend income to savings income.
Bond holders are taxed at their highest marginal rates of income tax (20%, 40% or 45%) on the bond gain.
But if they can take their bond profits at a time when they are non-taxpayers, then they have an advantage over Oeics.
Oeics will have suffered a tax drag on income during the investment period, and capital gains in excess of allowances on withdrawal could be hit with an 18% or 28% tax charge.
A gain from offshore bonds is savings income that, of course, has its own £5,000 tax-free band, although this is withdrawn when earned income begins to exceed the personal allowance.
And, in addition, from April the personal savings allowance (£1,000 for basic-rate taxpayers/£500 for higher-rate taxpayers).
As a result, to maximise the benefits of a bond, the trick is to extract at 0% tax, for example by surrendering while non-UK resident, using as a bridging pension by deferring taking benefits from pension plans, or assigning to non-taxpayers such as grandchildren at university who can cash in to finance their studies.
If this cannot be achieved, top-slice relief may be available to avoid or reduce higher-rate tax on any gains.
Existing investments
The changes may trigger a review of clients’ existing investments, but future tax savings by changing investment wrappers must be balanced against any immediate tax charges as a result of disinvestment.
A phased strategy of disinvestment across a number of tax years may also be considered to maximise the use of available allowances and reduce the tax payable.
The most suitable wrapper will always come down to individual circumstances. This has not changed. But with fresh tax allowances available it makes sense to ensure these are not wasted – and this could see a continued place for both investment wrappers as part of diversified portfolio. LW
