Minimising capital gains tax

aroominyork

Having worked through these helpful answers and run some numbers, can I please check that the best way to minimise tax for a higher rate taxpayer – in the situation where I receive a lump sum which will take a few years to tax-wrap – is to invest in income-generating funds* rather than dividend-generating funds (ignoring for a moment the £2000 dividend allowance and the personal savings allowance) and make SIPP contributions. For example:

·         Higher rate threshold = £50,000 (ignore the £270 for this example)

·         Salary £60,000: £4000 of HRT paid through PAYE

·         Interest from unwrapped fund (>60% fixed interest holdings) of £15,000: £6000 of HRT due

·         Contribute £20,000 net to SIPP; BRT claimed to increase this to £25,000

·         Higher rate threshold rises to £75,000

·         £5000 of HRT reclaimed through self-assessment (20% of gross SIPP contribution)

·         Bottom line: £10,000 of HRT due; £10,000 recovered through SIPP and self-assessment.

So this means that interest is taxed the same way as earnings and HRT on interest can be recovered through SIPP contributions in the same way as earnings, with the sole difference that income from interest does not raise the salary cap.

Holding bonds rather than equities in unwrapped accounts also reduces the likelihood of CGT being due.

* I can swap holdings between wrapped and non-wrapped accounts, to have the funds I want held in the accounts I want.

aroominyork

Many thanks for this, FeralHog. I have run the numbers a different way and reach your conclusion, but I am conceptually confused because tax on earnings and interest can always be reclaimed through SIPP contributions (subject to annual allowance and salary cap) whereas tax on dividends cannot be reclaimed; hence interest should trump dividends... shouldn’t it? I know the explanation is the difference between basic and higher rates (25% vs. 20%) but I need a day or two for that to penetrate the grey matter. However:

The interest calc is:

-          Income of £60k + £15k = £75k

-          £12.5k allowance, so BRT on £37.5k + HRT on £25k = £17.5k

-          Need to increase HRT threshold from £50k to £75k

-          Hence £20k net into SIPP, grossed to £25k

-          Reclaim £5k HRT

-          Result: £42.5k in bank, £25k in SIPP, £7.5k with HMRC.

The dividend calc is:

-          Income of £60k

-          £12.5k allowance, so BRT on £37.5k + HRT on £10k = £11.5k

-          Still need to increase HRT threshold from £50k to £75k for dividends to be taxed at the lower rate

-          Hence £20k net into SIPP, grossed to £25k

-          Reclaim HRT: I have only paid HRT on £10k so I can only reclaim £2k

-          So far: £60k - £11.5k - £20k + £2k = £30.5k in bank, £25k in SIPP, £11.5k - £5k - £2k = £4.5k with HMRC

-          Dividend income of £15k, taxed at 8.75%

-          Result: £44.1875k in bank, £25k in SIPP, £5.8125 with HMRC.

As you say, the difference is £44,187.50 - £42,500 = £1687.50; plus, since £2k of dividend income is tax-free, that shifts another £175 from HMRC to me.

If there is anything you can add to straighten out my thinking I would be grateful, though it’s probably just a matter of me re-reading your post a few times until it sinks in.

PS: I’ve worked out where this has gone a bit wrong. It’s because our calculations are based on making only enough SIPP contribution to raise the HRT threshold from £60k to £75k. In reality, I would make SIPP contributions that mopped up all my 40% tax. I have run this for three scenarios: £50k salary/£0 to SIPP; £60k salary/£8k net to SIPP; £80k salary/£24k net to SIPP. For the interest scenario I would make £12k more net SIPP contributions (so £12k, £20k, £36k respectively). In each scenario the tax paid on interest is £1312.50 less than the tax paid on dividends… which is 8.75% of £15,000. So the bottom line is that if I want more money in my bank I should go for dividends; but if I want to minimise tax and have £1312.50 more across my bank and SIPP I should go for interest.

talexuser

not too sure of your various assumptions but for example my calculations of transferring salary to SIPP with the actual allowances:

50k salary    15k of interest     0 to SIPP      tax = £13,286
50k salary     15k of dividends    0 to SIPP     tax= £11,874

40k salary     15k of interest     10k to SIPP    tax = £8,286
40k salary     15k of dividends    10k to SIPP     tax= £6,623

aroominyork

Yes, you are definitely at least partly right! My approach to SIPP contributions – when just investing salary, not planning for a lump sum – is to prioritise recovering all 40% tax I have paid, so I make a net contribution equal to 80% of the amount on which I paid HRT, eg salary £60k, HRT on 10k, net SIPP contribution of £8k.

I used that approach here – wrongly. For the £50k salary scenario I may not have any 40% tax to recover, but I need to make SIPP contributions to extend my HRT threshold and pay 8.75% on dividends. And as you pointed out, this results in a £1687.50 better outcome for dividends.

However, I still think – though could be wrong – that interest wins out if I am already a higher rate taxpayer. Take a salary of £65k, paying £12k net to SIPP and receiving £15k dividend or interest.

INTEREST

Gross salary + interest = £80k

Tax £19.5k, balance in hand £60.5k

£24k net into SIPP (80% of the £30k on which I pay HRT), grossed to £30k

Reclaim £6k through self-assessment

Result: £42.5k in bank, £30k in SIPP, £7.5k with HMRC

DIVIDEND

Gross salary £65k

Tax £13.5k

£12k net into SIPP (80% of the £15k on which I pay HRT), grossed to £15k

Reclaim £3k through self-assessment

£15k dividend income, paying 8.75% tax = £1312.50

Result: £56,187.50 in bank, £15k in SIPP, £8812.50 with HMRC.

Interest reduces tax burden by £1312.50 (8.75% of £15,000).

Thanks for your patience on this; am I right or wrong?

aroominyork

OK, I see where I have been going wrong. It is a red herring to think the tax on interest can be recovered; my salary cap does not change so I can reclaim the same finite amount of tax through SIPP contributions whether or not I pay tax on interest. So tax has to be paid - and kept by HMRC - whether I receive interest or dividends and, so long as I avoid a higher rate trap, it is, like you said, the difference between 20% and 8.75%. Thanks.

talexuser

at today's allowances
65k salary, 15k interest, 24k SIPP, tax = £13286 
65k salary, 15k dividends, 12k SIPP, tax = £14873
65k salary, 15k dividends, 24k SIPP, tax = £11623