The erosion of capital gains tax (CGT) allowances has caused headaches for people with large portfolios, often leaving them with one of two unappealing options: pay a large tax bill or allow their portfolios to become completely lopsided.
Eleanor Ingilby, head of high net worth at atomos, said this has been one of the “biggest challenges” she has faced in recent years, as clients have had to become more at peace with paying the tax if they want a diversified, well-managed portfolio.
CGT affects anyone with a general investment portfolio and more money than they can invest in a stocks and shares ISA.
For example, someone with a £500,000 portfolio outside of an ISA will struggle to ever get their money inside a tax wrapper. This is because their portfolio requires a 4% return to overtake the full £20,000 per year ISA allowance.
The tax only applies once an investment is sold and the gains are realised. As a result, if never sold, the investor will never have to pay CGT. This is a catch-22, however, as the individual may need to sell eventually, incurring a much larger CGT bill (as investments continue to rise) than if they had sold each year.
This matters because it can affect how investment managers or individuals trade. Yet many of Ingilby’s older clients refuse to accept they need to pay the tax.
“Clients who are, say, 60 or 70 years old and above see capital gains tax as an optional tax, something they can easily avoid,” she said.
This is because the annual CGT allowance used to give enough room for investors to freely trade without paying tax – for most individuals anyway. The allowance peaked in 2020/21 at £12,300 but was more than £10,000 for a decade before this.
More recently, however, it has been used as a way for the government to get people to pay tax. After several cuts, the allowance stands at just £3,000 today.
Moreover, the amount that investors have to pay has increased. In her first Budget, chancellor Rachel Reeves increased CGT rates from 10% to 18% for basic rate taxpayers and from 20% to 24% for higher and additional rate taxpayers.
“Historically you had a big enough allowance that we could probably run you a pretty diversified portfolio without generating too much additional capital gains tax,” said Ingilby.
“Now, I would say the government has changed that and it is nigh-on impossible to run a diversified portfolio without paying capital gains tax.”
As such, people with large taxable portfolios need to understand CGT is no longer an elective tax if they want to ensure diversification, a concept that has been “more of a battle than you might think”, the head of high net worth said.
What has proven effective is atomos’ in-house data, which compares performance of a client’s portfolio after three years of attempting to avoid the tax.
In some cases, people have held on to investments that they have not necessarily wanted to own. In others, they have sold assets at a loss rather than incurring CGT. Both methods have “distorted the shape of their portfolios”, she said.
In many cases, it shows clients would have made more money if they had traded freely but paid the tax than by refusing to sell stocks that ought to be removed.
For some, it is only at this point that the client understands the risks associated with myopically trying to avoid paying capital gains tax.
“It's been a really challenging discussion, but I think the majority of clients now do understand it isn't optional,” said Ingilby.
CGT has come back into the spotlight this week as Labour MP Wes Streeting has suggested CGT should fall in line with income tax.
Streeting is one of the key candidates to become chancellor should former Manchester mayor Andy Burnham – fresh off his Makerfield by-election win – become the next prime minister.
There is one way out of paying CGT, however: dying. Ingilby noted that capital gains get reset at a person’s death, meaning any tax owed is also reset.
“I have a wonderful client who's 92 years old and sharp as a tack. His wife, who's a little older than him, holds a lot of taxable assets in her portfolio and their strategy is to die. That's their way of dealing with the capital gains on their portfolio,” she said.
“So I joke with clients — I say there's two strategies: you pay it, or you die.”
Even this could be under threat under the new government, however. Louise Haigh, another Labour MP and close ally of Burnham, has called for the abolition of the capital gains uplift on death.
Jason Hollands, managing director at Evelyn Partners, said: “At this stage, any potential changes to CGT are just speculation. Tax policy is ultimately a matter for the chancellor and we don’t know for sure who that will be by the time of the next Budget.
“There is no certainty that any of the proposals currently being advocated will ever become policy. Investors should be wary of making knee-jerk decisions simply because of political debate.”
However, he noted that in 2024, the CGT hikes took effect from the day of the Budget itself, leaving no time for tax planning.
"Anyone considering crystallising gains ahead of a potential future increase would therefore be wise to review their position well in advance of any future Budget rather than assume there will be an opportunity to act afterwards,” he concluded.