Do you pay tax on investment income and gains?
You may have to pay income tax on investment income generated from your UK investments. The tax rate on your investment income will vary depending on the type of income you receive, and the type of investment product you receive it from. Investment income, when liable to income tax, will count towards your total UK earnings when calculating your income tax liability in a given tax year. Examples of investment income include dividends or interest payments received from investments.
You may also be liable to tax on capital gains you make on your investments i.e. the difference between the price you sell an investment for above the price paid for that investment. Any capital gain may be liable to Capital Gains Tax (CGT). CGT is payable on stocks and shares which can either be held directly or within an unwrapped portfolio, sometimes referred to as a General Investment Account (GIA) or Share Account.
Although most people may not think of their pension as an investment, pension funds have the ability to be invested in the stock market the same way as any other investment. Pensions are a tax efficient way of saving for retirement as the money within your pension grows free of any income tax on income and CGT on capital gains. However, it is worth noting that any income you take from your pension (in excess of the 25% tax free amount) will be taxed at the marginal rate of income tax.
How much is tax on investment income and gains?
Tax on investment income and capital gains come at different rates, depending on the type of income you receive and the type of capital gains made. Most rates of tax on investment income and capital gains are dependent on the individual’s marginal rate of income tax. Your marginal rate of income tax is the tax rate you would pay on your next pound of income. An individual’s marginal rate of income tax can be calculated by adding together all relevant total UK earnings for a tax year, and then seeing which tax bracket they fit into.
Dividend income is taxed at the dividend rate of income tax. This is 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.
Typically, all other sources of investment income, including interest payments, are taxed at the same rates as earned income. These rates are 20% for a basic rate taxpayer, 40% for a higher rate taxpayer and 45% for an additional rate taxpayer.
The rate of CGT for capital gains on investments is 10% for basic rate taxpayers and 20% for higher and additional rate taxpayers. For basic rate taxpayers, if the gain when added on top of all other sources of income pushes you into the higher rate band, the part that falls within the higher rate band will be subject to the higher rate of CGT. These rates are applicable for capital gains on all investments except residential property, where the rates are 18% and 28% respectively. CGT is typically not payable on any increase in value of your main residence from the point of purchase until when sold.
How to reduce taxes on investment income and gains
There are various allowances that allow you to receive investment income and make capital gains on your investments without paying tax of any kind. Above these ‘thresholds’ you will pay the tax rates outlined above on investment income and capital gains.
Capital gains tax allowance: An individual can make £6,000 worth of capital gains within a tax year without paying any CGT. If total capital gains equate to more than this allowance, you pay CGT on the difference between the total gain value and the allowance. If you generate a capital loss in any given tax year (i.e. investments are sold for less than they are bought for), you can use these losses to offset potential gains in future tax years.
As the CGT allowance is per individual, setting up a jointly owned investment portfolio means that you have twice the level of allowance to use to potentially shelter capital gains from tax.
Note that the CGT allowance is due to be cut to £3,000 per individual per tax year from 6th April 2024, hence it could be worth considering ‘realising’ capital gains in the current tax year before the allowance is reduced.
Personal allowance: the personal allowance is how much income from all sources one can receive in a tax year before they are subject to income tax. Currently the personal allowance is £12,570 per tax year. Keeping income within this allowance level in a given tax year would mean no income tax would be payable that year on all types of potentially taxable income including earned, rental and taxable pension income.
Starting rate for savings: If your taxable non-savings income is below £17,570 for the tax year, you may also receive up to £5,000 of interest from investments and not have to pay tax on it. This allowance is reduced by £1 for every £1 of non-savings income above the personal allowance.
Personal savings allowance: this is an annual tax-free allowance that protects interest payments from tax. The allowance you get depends on what rate of tax you pay. Basic rate taxpayers have an allowance of £1,000 and higher rate taxpayers have an allowance of £500. Additional rate taxpayers do not receive an allowance.
Dividend allowance: the dividend allowance allows you to receive dividends of £1,000 per tax year before you start paying tax. Above the allowance, the dividend rates of income tax, highlighted above, apply to any dividend income. As is the case with the CGT allowance, the dividend allowance is due to be halved from 6th April 2024 (to £500 per individual per tax year).
Alongside making use of these valuable allowances, an Individual Savings Account (ISA) is a great way to invest given within the ISA wrapper capital gains and investment income are tax free. There is also no income tax payable when taking funds out of an ISA. You can invest up to £20,000 per individual per tax year into an ISA which can be investment-based or cash-based.
How to calculate tax on investment income and gains
The first step of calculating the potential tax payable on investment income and capital gains is adding together all sources of income received, excluding that from investments or savings. This includes employment or self-employed income, pension income, rental income and trust income. This will help determine your marginal rate of tax and also impacts some of the tax-free allowances.
Next, subtract any relevant tax-free allowances highlighted above from investment income received or capital gains made. If investment income and/or capital gains fall within the allowances, no tax is payable. Please however note investment income, even if falling within the tax-free allowances, does count towards total income which can affect these allowances as well as other allowances.
If any investment income or capital gains fall above the tax-free allowances, the above-mentioned tax rates will apply. Interest payments are the first to be taxed and then dividend income. Any capital gains will ‘sit on top’ of all earned income including investment income. Beware receiving investment income as a basic rate taxpayer could result in a capital gain being pushed into the higher rate.
How to report investment income and capital gains on tax return
You must complete and submit a Self-Assessment tax return to HMRC if you have received investment income or made capital gains above your tax-free allowances in any given tax year. Note, there are other options for reporting investment income if it does not exceed £10,000 for a tax year and you wouldn't ordinarily complete a tax return - for more information read the following information around tax on dividends and applying tax free interest on savings.
To complete a Self-Assessment tax return to report investment income or capital gains you should do so after the tax year ends on 5th April. You then have until midnight on 31st January following the tax year end to file your Self-Assessment tax return online. If you do not usually send a tax return, you need to register by 5th October following the tax year in which you received investment income or made capital gains.
How can we help?
Our tax planning services include certain products, allowances and guidelines to ensure your money is working its hardest and the tax you pay is minimised where possible.
Our advisers stay on top of all changes to tax legislation within the UK and notify clients as to how and why changes may affect their financial situation.
To find out more about how we can help or for a free initial consultation why not get in touch.
Please note: The Financial Conduct Authority (FCA) does not regulate tax advice.
A pension is a long-term investment not normally accessible until age 55 (rising to 57 from April 2028). The value of your investments (and income from them) can go down as well as up, so you may get back less then your originally invested.
Your pension income could also be affected by the interest rate at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change.
You should seek advice to understand your options at retirement.