Taxation changes announced in last week’s Budget could mean an overhaul of the way intermediaries construct portfolios for high net worth clients.
The 8 percentage point cut to the rate of capital gains tax (CGT) unveiled on March 16, when combined with changes made to dividend taxation in last year’s Budget, represents a “game changer” for the way in which portfolios are structured, according to one strategist.
The changes will also mean that a higher or additional rate taxpayer will receive a £5,000 tax-free allowance for dividends as of this April, but an £11,100 allowance for capital gains.
Dividends will otherwise be taxed at 33-38 per cent, whereas the CGT rate has been cut to 20 per cent.
Charles Cade, head of investment company research at Numis Securities, said the changes meant the wealthiest investors would be better off taking an income via the sale of securities and incurring CGT.
“You should still be focused on total return rather than just chasing income at the moment,” Mr Cade said.
“That’s ultimately the key when choosing investments, and with the new tax regime it builds a stronger case for that strategy. It’s taking a longer-term view on what you’re likely to get.”
Income investing remains a core part of most adviser-led strategies and has become more pronounced since the introduction of pension freedoms in April 2015.
The rise has been accompanied by a growing emphasis on the risks of drawing down capital, including the problem of pound cost ‘ravaging’ – the risk that sharp market falls and regular withdrawals result in capital being eroded – for those close to retirement.
But the taxation changes have prompted some businesses to reconsider the structure of their portfolios.
Rory McPherson, head of investment strategy at Psigma, described the CGT cut as a “game changer”. He said they would affect “what goes into the Isa portfolio and [what goes into] the taxable portfolio”, as well as income investing more broadly.
He added this year’s reduction to CGT made it “much more attractive for investors to take income from their gains rather than dividends”.
If an investor cashed out their £1m in savings for a retirement income and aimed for a 5 per cent yield (of £50,000), they could draw down £8,000 a year less doing this via capital gains, Mr McPherson said.
“If they are set up for a 5 per cent yield, then after tax they would be receiving about £39,000 per year.
“[If] they now moved to having no interest being paid and went all out for capital gains, to get the same total income of £39,000 a year they would only need to draw down £42,000 a year,” he explained.
“I think this has really interesting implications for income investing and could be quite powerful for how people structure their portfolios.”
Simon Bashorun, financial planning team leader at Investec Wealth & Investment, agreed the changes “will make drawing on capital each year as a form of ‘income’ even more attractive than it currently is. This reinforces the need for individuals to build up portfolios which can provide gains to draw down on tax efficiently in the future”.
Mike Horseman, managing director at Cockburn Lucas Independent Financial Consulting, said the tax changes also have interesting planning applications. He said it would be crucial at the point of decumulation to ensure allocation of capital across a number of tax-efficient wrappers.
“A switch to growth or total return [investing] to utilise CGT allowances could start to feature for high net worth clients,” Mr Horseman said.
Views from financial planners
Sarah Harragan, financial planner at Grangewood Financial Management:
“It is generally more efficient to invest for growth, even when investing for income. Taking ‘income’ by way of capital withdrawals provides greater flexibility, as you only take what you want when you need it, and is more tax-efficient. In most cases you can get the income required via capital withdrawals that stay within the CGT allowance.”
Andy Springford, financial planner at Mazars Financial Planning:
“Total return should be the main focus for investors as it’s important to be able to utilise an individual’s CGT exemption, and therefore gains can become more important than income generation when it comes to tax efficiency. Whether or not the cut in CGT rates to 20 per cent will have any significant impact on the way people look for returns is yet to be seen.”
Matthew Harris, owner of Dalbeath Financial Planning:
“We have always advocated selling down units in funds if a monthly income is needed, as this allows the income to be predictable and steady. CGT allowances are enough to avoid any tax being due on such redemptions for all but the largest investors. The change in dividend tax will hurt some investors, but will not change the design of our portfolios of investment funds.”
