In the third of three case study-based articles, Julia Peake – Technical Manager at Nucleus, looks at how making a pension contribution, could reduce a client’s CGT bill.
When clients dispose of certain assets, they could be liable to CGT, depending on the size of the gain, the available annual exempt amount (AEA), if the client has any losses available and if other reliefs might be claimed.
CGT is normally assessable when assets are disposed of such as shares (outside of pension and ISAs), investment properties and business assets.
Individuals may be able to claim certain reliefs such as business asset disposal relief and gift hold over relief depending on the circumstances and they should seek tax advice before doing so.
For more information about CGT and what is chargeable please see Capital Gains Tax: what you pay it on, rates and allowances: What you pay it on – GOV.UK.
Individuals and trustees have an AEA to offset against gains upon disposal. The current values are £3,000 for individuals and £1,500 for trustees.
However, the trustees value will depend on the number of settlements the settlor has created up to a maximum of five. This means it could be as little as £300 per trust and you cannot assign it to the trust which may make best use of it, the amount is automatically divided.
Individuals may also have losses which then could use to offset any gains. Losses which have been made in the current year should be used first against any gains. If gains exceed the loss, then the annual exemption could be set against the excess.
If your loss is greater than your chargeable gains in the current year, losses can be carried forward indefinitely to set against gains in future tax years, so long as you register these with HMRC within four years of the loss occurring.
CGT chargeable assets disposed of in favour of a spouse or registered civil partner are done so on a “no loss, no gain” basis, so long as it is an outright gift. This may be a useful planning tool to ensure both AEAs can be utilised in a tax year, or if one of the couple is a lower taxpayer.
Gains in excess of AEA or losses are charged at 18% for basic rate taxpayers or 24% for higher and additional rate taxpayers as well as trustees.
But if pensions are not liable to CGT how does making a pension contribution reduce an individual’s tax bill?
It’s because the rate of CGT is linked to the client’s income tax rate and if you extend the basic rate band by making a pension contribution, you may also be able to reduce the CGT bill upon disposal.
Case study: How this works in practice
David has a gross salary of £47,000 (£34,430 net of tax) making him a basic rate taxpayer and leaving £2,970 of the basic rate band (BRB) available before higher rate tax applies.
He sells some shares which after his AEA gives him a chargeable gain of £10,000. He has no losses to offset against the gain.
When assessing the CGT payable we look at the total taxable income and income tax rate of the individual. Once the £10,000 gain is added to the income, then part of the gain would be chargeable at higher rate tax:
£2,970 (BRB) x 18% = £534.60
Remaining £7,030 X 24% = £1,687.20
Total = £2,221.80 CGT to pay.
If David makes a £5,600 net/ £7,000 gross pension contribution the basic rate band is extended by the gross figure so higher rate tax would then start at £57,270. Therefore, the capital gain of £10,000 would fit into the extended basic rate band:
£10,000 x 18% = £1,800 CGT to pay giving a tax saving of £421.80.
In addition to the tax saving David also benefits from:
- Tax efficient saving for retirement and tax relief on the contribution made.
- Tax efficient growth, free from income tax and CGT. Also until the rules change in April 2027, inheritance tax free on death.
Other case studies in this series:
Disclaimer:
This information is based on our understanding of current legislation, including (but not limited to) FCA, PRA and HMRC regulation. It does not constitute any form of advice. Nucleus will take no responsibility for any loss which may occur as a result of reliance on this information.
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