Do you pay tax on investment income and gains?
You may have to pay tax on income you take from your UK investments. The tax rate on your investment income will vary depending on the type of income you take, and the type of investment product you take it from.
One type of tax that you may be liable to on your investments is Capital Gains Tax (CGT). This is a tax on the gain you make on your investments i.e. the difference between the price you paid for the investment and the price you are selling them for. 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.
The second type of tax that may be payable on your investment income is income tax. Investments taxed in this way will count towards your total UK earnings when calculating your income tax liability in a given tax year, such as rental income. Income tax is also payable on any dividends you take from your investments at the dividend rate of income tax.
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 capital gains tax and income tax (i.e. within the fund), however, any income you take from your pension (in excess of the 25% tax free amount) will be taxed at the individual’s marginal rate of income tax.
How much is tax on investment income and gains?
Tax on investment income comes at different rates, depending on the type of income you are taking. Most rates of tax on investment income and gains are dependent on the individual’s marginal rate of income tax. Your marginal rate of income tax, this term relates to the tax a person would pay on their next pound of income, is calculated by adding together all your total UK earnings and seeing which tax bracket this fits into.
The rate of capital gains tax is 10% for basic rate taxpayers unless any of the gain crosses over into the higher rate band when added on top of income (in which case, that part is taxed at 20%) for gains on your investments. This is applicable for all investments except residential property, where the rates are 18% and 28% respectively. Capital gains tax is not payable on any gain made on your main residence.
Dividend income is taxed at the dividend rate of income tax. This is 8.75% for basic rate income taxpayers, 33.75% for higher rate income taxpayers and 39.35% for additional rate income taxpayers.
Income tax is payable on pension income and rental income. The basic rate of income tax is 20%, higher rate is 40% and additional rate taxpayers pay 45%.
How to reduce taxes on investment income and gains
There are various allowances that allow you to take income and gains from your investments without paying tax of any kind. These allowances act as a ‘threshold’ over which you will pay the tax rates outlined above on your various investment income and gains.
Capital gains tax allowance: An individual can take £12,300 worth of gains every tax year over their entire investment portfolio without paying any CGT. If the gains equate to more than this allowance, you pay CGT on the difference between the total gain value and the allowance. If your portfolio loses money in any given tax year, 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 share portfolio means that you have twice the level of allowance to use meaning the share portfolio could give overall a higher level of gain tax free.
Personal allowance: the personal allowance is how much income one can take in a tax year before they are subject to income tax. Currently the personal allowance is £12,570. Keeping income within this allowance level in a given tax year would mean no income tax would be payable that year, this includes all types of income that are subject to tax, such as earned, rental and taxable pension income.
Dividend allowance: if you take dividends from your investments the dividend allowance allows you to take £2,000 per tax year before you start paying tax. Above the allowance, the dividend rates of income tax, highlighted above, apply to any dividend income.
An Individual Savings Account (ISA) is a great way to invest and take income without having to pay tax of any kind. ISAs are able to grow free from CGT and income tax (within the ISA), and there is no income, dividend or GGT tax to pay when taking income out of the wrapper. You can invest up to £20,000 per year into an ISA which can be invested into stocks and shares, as well as kept as cash.
How to calculate tax on investment income and gains
Calculating the tax you owe on your investment income depends on whether it's income or capital gains, the type of income it is, and the tax bands it falls into (earned/rental/pension income come first, then interest, then dividends, then taxable capital gains). These various allowances are explained above.
Add together all gross income taken from your investment portfolio as either:
- Capital gain, dividends, other income (such as rental income or pension income),
- Subtract any relevant tax-free allowances. Please note, however, dividends and interest falling within the dividend allowance or PSA still use up some or all of the tax band they fall into and can push other income/gains into a higher tax band. These aren't just removed from income even though they might be tax free,
- Apply the tax rate that is applicable to your marginal rate of income tax to the figure that is left over. However, this depends which tax band(s) the income and gains fall into (bearing in mind that all dividends and all interest etc is taken into account and uses up part of the tax bands, even if technically 'tax free' due to being within the dividend allowance or PSA),
This is your net investment income and gains.
How to report investment income and capital gains on tax return
You must fill out and submit a Self-Assessment tax return to HMRC if you have received income from your investments and dividends in any given tax year. Note, there are other options if not over £10k and the person 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 gross income from investments or shares you should do so after the tax year ends on 5 April. You then have until midnight on 31 January to file your Self-Assessment tax return online. If you do not usually send a tax return, you need to register by 5 October following the tax year you had the income. The deadline for submitting online is 31 January the following year.
How can we help?
Our tax planning services include certain products, allowances and guidelines to ensure your money is working its hardest and to ensure the tax you pay is ultimately a fair, yet minimal, amount.
Our advisers stay on top of all changes to taxation 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.