Bed and ISA: the handy tax trick to boost your wealth

Managing your investment portfolio is a bit like running a car. Every now and then it’s essential to lift the bonnet, check that everything is in working order, and make changes where necessary.

Core to the servicing process for investors is to maximise any tax-saving opportunities. This will enable you to keep more of your growth and income, helping put some extra miles on your portfolio’s clock.

• Invest with ii: Open an ISA | ISA Investment Ideas | ISA Offers & Cashback

As the end of the current tax year edges closer, this task is particularly important right now. That’s because if you don’t use certain allowances and exemptions by 5 April, they might be lost for good.

One of these is your annual capital gains tax (CGT) exemption, which allows you to realise a certain profit every year from selling shares and not pay tax.

This allowance, however, halved from £12,300 to £6,000 at the start of the current tax year and will halve again to £3,000 from 6 April 2024. This means you will have less scope to encash holdings outside of tax wrappers, such as pensions and individual savings accounts (ISAs), and keep HMRC at bay.

What’s more, as you can’t roll over any unused CGT allowance to future tax years – it’s either “use it or lose it” - this should form a key part of your annual portfolio maintenance.

An effective way to make the most of this exemption is to use something called “Bed and ISA”. Here I explain the benefits of this approach and outline how to go about it.

But first let’s briefly delve into how CGT works.

How does CGT apply when selling shares?

You might be liable for CGT when you sell, gift or transfer shares that have increased in value.

The size of your tax bill depends on whether the gain falls within the basic-rate tax bracket or the higher-rate one. Any profit - when added to your total income - below £50,270 is liable to 10% tax, while anything above is taxed at 20%.

This may apply when selling shares in something like a general investment account (GIA), as unlike ISAs any gains and dividends are taxable.

The table below shows how the swingeing CGT allowance would affect an investor who makes a £15,000 profit from selling shares.

In this example, a higher-rate taxpayer could see their CGT bill rise £1,860 in just two tax years – a painful thought. But this is where the value of regular and thorough portfolio check-ups is underscored.

The Bed and ISA trick

Bed and ISA is a rather knotty piece of industry jargon, so let’s unpack what it is, and explain how to make the most of it.

Put simply, it’s a process where you sell holdings outside of tax wrappers and repurchase them within your ISA. Provided the profit you realise for the tax year in question (you can also deduct any losses you’ve made) is within the CGT allowance it should not trigger a tax charge.

• How to swerve a big CGT bill
• How to shield a financial windfall from the taxman

The idea is that by redirecting the money to your ISA, any future gains and income will escape the taxman’s grasp, allowing you to keep more of your money.

Bed and ISA in action

Here’s an example of how Bed and ISA can work.

You invested £20,000 into your GIA in 2015, buying a multi-asset fund at a cost £1 a unit. By January 2024, the unit price had increased to £1.60, taking the value to £32,000.

You decide to encash 10,000 units – a sum of £16,000.

To work out the gain, you simply subtract the acquisition cost from the sale price, which in this case is £16,000 (£10,000 x £1.60) - £10,000 (£10,000 x £1) = £6,000.

As the current CGT allowance is £6,000, provided you haven’t realised any other gains during the tax year, you won’t face a tax charge, and can redirect the full £16,000 into your ISA.

Admittedly, this is a simplified example. If you’ve made several investments into the same fund at different unit prices, you will need to work out the average.

• 10 hottest ISA shares, funds and trusts: week ended 19 January 2024
• 2024 Investment outlook: share tips, forecasts, tax, pensions and savings
• Six savvy tax tricks to save you money in 2024

And it’s when you use Bed and ISA every year that it really makes a difference. Over time, the aim should be to gradually phase all GIA funds into tax wrappers without being hit with CGT along the way. Clearly this happened a lot faster when the allowance was £12,300, but highlights why it’s so important to consider using the £6,000 allowance this year.

It’s worth remembering that, while you can swerve a future CGT bill, any holdings within your GIA could still be subject to dividend tax.

The dividend allowance, which is the value of dividends you can receive every year and not pay tax, will halve from £1,000 to £500 from April 2024, after halving from £2,000 at the start of the current tax year.

What if I’ve already used my full ISA allowance for the 2023-24 tax year?

Well, even if you’re fortunate enough to be in this position, it can still make sense to use the higher CGT exemption while you still can. There are only a couple months left of the current tax year, and from 6 April your £20,000 ISA allowance resets.

Using the current CGT allowance can give you a head start for the 2024-25 tax year.

However, if you currently make large monthly contributions, you must check that you have enough spare.

For instance, if you pay £1,500 into your ISA every month (12 x £1,500 = £18,000) and intend to keep this up from April, you will only have £2,000 leftover.

As an alternative option, although you may have maximised your own ISA allowance, your spouse or civil partner may not have.

Married couples and civil partners can effectively double their ISA allowance to £40,000 every year and you also both get an annual CGT exemption, widening the scope for tax-saving opportunities.

• Jeff Prestridge: these funds are robust long-term pillars of an ISA
• My first five years as an ISA investor
• How I plan to invest my ISA allowance in 2024

A further upside here is that asset transfers between spouses and civil partners are exempt from CGT. So if the shares are held in your name only, you could transfer some or all your portfolio into your spouse’s name after you’ve used your CGT allowance, and boost your combined exemption to £12,000 for 2023-24.

And if your better half pays a lower rate of income tax, you may also trim your future dividend tax bill in the process.

In the event that both your ISAs are maxed out, you could consider supporting future generations.

If you have young children and would like to give them a financial leg-up once they reach adulthood, you could use your CGT allowance and redirect the money to a Junior ISA (JISA). The maximum you can save every year into a JISA is £9,000 and this doesn’t count towards your own £20,000 ISA allowance.

This decision to support your kids will depend on whether you’re happy to give this wealth away.

How to Bed and ISA with ii

The Bed and ISA process may sound a bit complicated, but many ISA providers, including interactive investor, have a straightforward process.

For ii account holders, there are three simple steps:

1) Log into your trading account and choose Bed and ISA from the cash & transfers menu.

2) Select your accounts, check your remaining ISA subscription, and choose the investments you want to Bed and ISA.

3) Leave the rest to ii. We’ll let you know when the process is complete.

If you have a general trading account with interactive investor, you'll only pay a trading fee on the re-purchase, not the sale.

While the end of the tax year is still more than two months away, starting the Bed and ISA process as soon as possible is strongly advised.

There is usually a cut-off point for Bed and ISA transactions a week or so before tax year end to make sure the sale and purchase goes through in time. And this year is likely to be busy as investors scramble to use the higher allowance while they still can.