Clearing up capital gains tax

Capital gains tax is changing in the new tax year (from 6 April 2023), so it feels like a good time to clear up what capital gains actually are, how they’re taxed and how this tax is changing. Plus a few investing hacks to help you keep your investment gains as tax-free as possible! 💡

What are capital gains?

It really is pure financial jargon, 🙄 but ‘capital gains’ translates to the profits (‘gains’) made from the sale of something you own (‘capital’).

Not everything you sell and make a profit on will count as a capital gain – or something you need to pay capital gains tax on. But profits made from the sale of an investment do, and you may need to pay tax on them. 💰

The government call all the things you can sell and make capital gains on ‘chargeable assets’ (sorry, it really is a jargon-heavy topic!). There are other items besides investments on the list, so when you get a sec, it may be worth checking all the things you could end up paying capital gains tax on.

But let’s not get bogged down on the other ways you can make capital gains and be taxed on them. This article is laser-focused on investments, like funds and shares, and when and how you might have to pay capital gains tax when you sell them. 👇

What is capital gains tax? 💼

Capital gains tax (often shortened to ‘CGT’) is the type of tax you might have to pay on the profits you make when you sell an investment, like funds and shares, outside of an ISA or pension.

So if you have, or plan to buy, any investments outside an ISA or pension, just keep one eye on capital gains tax. Make sure you understand if and how it applies to you, and how it’s changing over the next few years.

Though this post hopes to clear up how capital gains tax works – it’s not advice (remember, Dodl doesn’t do advice!). More info is available on the government’s capital gains tax page and do seek personal tax advice if you need to.

What is the capital gains tax allowance? 💸

Everyone can make some gains before they have to start paying tax. This tax-free amount is called the capital gains tax allowance and it’s £12,300 for the 2022/23 tax year, but it’s getting smaller and smaller over the next few years (more on this later).

Any amount you make above the allowance is taxable, and you’ll also have to let HMRC know about it in your self-assessment or using their real-time capital gains tax service. 📝

💡 This tax-free allowance is ‘use it or lose it’ – it resets every April and if you don’t use it all, you can’t carry whatever’s left of it into the next tax year. Just something to bear in mind!

What are the capital gains tax rates? 📊

The capital gains you make on your investments above the tax-free allowance will be taxed and a proportion of them will be taken off the top by HMRC. Your rate of capital gains tax i.e. the proportion of your gain that gets taken, depends on your level of income. You’ll be charged a tax rate of 10% if you’re a basic-rate taxpayer, and 20% if you’re a higher (or additional)-rate taxpayer.

 

Income rate	Capital gains tax rate
Basic	10%
Higher	20%

 

Just so you know, your taxable capital gains will be added to your income for the year when working out the rate you’ll pay - so if you’re at the top end of the basic-rate, your gain could tip you into higher-rate territory.

Side note 📝: capital gains tax rates are higher for the gains made from the sale of a second home. This article doesn’t focus on those types of gains, but you can find out more about how they’re taxed on the government’s capital gains tax page.

How is capital gains tax changing? 📅

The capital gains tax rates aren’t changing but the allowance is. Over the next two years, the capital gains tax allowance is being slashed by over 75%. It’ll be cut to £6,000 from 6 April 2023 and again to just £3,000 from April 2024. It’s a savage cut to the tax-free allowance and means around a quarter of million more people will have to pay capital gains tax – and report their gains to HMRC.

 

A little example goes a long way! 😅 Say each year you make £10,000 in profits from your investments outside of an ISA or pension – very nice! (We’ll keep the amount of gains the same each year, for simplicity.) Let’s also say you’re a basic-rate taxpayer on a salary of £30,000 a year (which also doesn’t change, only for the benefit of the example!). You have no other taxable gains or income. This tax year (2022/23) the tax-free allowance is £12,300 so you wouldn’t pay any capital gains tax whatsoever and keep that full £10K investment profit. Wonderful. Next tax year however (2023/24) you’d pay tax on the amount above £6,000 – so you’d pay tax on £4,000 of your investment profit. Because you’re a basic-rate taxpayer, your capital gains tax rate is 10%. That means you’d pay £400 in tax next year. The following tax year (2024/25) sees the tax-free allowance drop again to £3,000, so you’d be paying tax on £7,000 of your total £10,000 of gains. The taxable gain doesn’t lift you into the higher income rate, so you’ll still be paying 10% capital gains tax – but it’s £700 this time because more of your gain is taxable.

Best investing hacks to save your gains from tax 😎

Prioritise using your yearly tax-free account allowances. The ISA allowance is a sizeable £20,000 – you can put up to that amount into your investment ISA each year and invest it all tax-free. Capital gains tax can’t touch your investment profits when they’re safely wrapped up in an ISA.

And don’t forget the tax perks of your pension too. You can usually save up to £40,000 (increasing to £60,000 from 6 April 2023) or your salary (whichever is lower) to your pension each year. Again, whatever you invest your pension savings in can be sold capital gains tax-free.

Investment ISAs (including lifetime ISAs) and pensions are most definitely your friends when it comes to investing in a tax-savvy way. So, if you’re thinking about starting to invest, it might be worth looking at opening these accounts first.

Check out the Dodl investment ISA, lifetime ISA and pension for more info on each. Or, if you’re already set up with them, give some thought to topping them up - to boost your tax-free investments for this year. 💪

If you invest outside an ISA or a pension, for example in a general investment account, and your investments have grown in value, you might find you have to pay capital gains tax once you’ve sold your investments.

Here’s where it’s important to bear in mind the capital gains allowance and how much smaller it’s getting over the next few tax years. Remember you can’t carry forwards any unused allowance from this year, so check if you have any gains that you want to cash-in now to avoid having to pay more tax next year.

Ready to invest in your best life?

Open a Dodl account today

 

🔔 Just remember with all these tax-related bits, tax rules can change (and clearly do!). The info in this article isn’t a substitute for personal tax advice so if you do need that, you’re best off contacting a professional tax adviser. And when you invest, the value of your investments can go down as well as up.