Using your pension top-ups to mitigate the effects of CGT

Following the emergency Budget, the Chancellor, George Osborne, has confirmed that the 28 per cent capital gains tax (CGT) rate introduced for higher-rate tax payers would remain in place for at least the length of this parliament.

From a financial planning perspective we now have some certainty about the rules, which enables us to make positive decisions for our clients about how best to reduce the impact of CGT until at least May 2015. This also gives you more stability and certainty when it comes to your tax and investment planning.

The threshold for gains before CGT becomes payable is £10,100 (2010/11) for all. Most basic-rate taxpayers could face 18 per cent tax on gains above this, while higher-rate taxpayers may be subject to a 28 per cent CGT rate.

A pension can be used as a highly effective tax shield, so the higher the rate of CGT, the more incentive there is to place funds under the protection of a pension. If you are now facing a 28 per cent CGT rate, we would like to have the opportunity to discuss the options available to you. Even as a basic-rate taxpayer you may for the first time find that your gains, when added to your income, push you into paying the higher-rate of CGT.

Selling an asset with gains over the CGT threshold would generate sale proceeds that could be used to fund a pension contribution that would attract tax relief of 20 per cent plus a further 20 per cent for higher-rate taxpayers to claim back through self-assessment. The tax relief could enable you to reduce the effect of any CGT that is paid and contribute to recovering any investment losses from falling markets.

It may be important that you maintain exactly the same portfolio of assets and the same investment strategy. This is possible through an in specie (the distribution of an asset in its present form, rather than selling it and distributing the cash) contribution of assets (or part of the asset, such as a property) which is viewed as a disposal for CGT purposes but also attracts tax relief.

Some Self-Invested Personal Pension (SIPP) providers may not allow in specie contributions in this way but those with experience can manage the process to ensure investors work within the overall contribution limits to maximise the benefits.

An alternative option if you’re a higher earner could be to sell your portfolio into the SIPP. In this instance, CGT would be payable on the sale and there is no tax relief as it is not a contribution. But it could be a useful way of releasing cash held by the SIPP back to you while sheltering the assets from any future CGT liability.

If you’re a high earner there may be other advantages to using pension arrangements. An example of this is if you find dividend income or rent from property push your earnings over £100,000 so that your tax-free personal allowance is reduced. In this instance, shifting the assets into a pension would protect against both an effective rate of income tax of up to 60 per cent and CGT going forward.