Why the term ‘Bed & Isa’ means more this year than ever before

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investment platform and coaching service, comments:

Time is ticking and with less than five weeks until the end of the financial year at midnight on April 5 – Britons are starting to realise that the end of this tax year could be one of the most important yet.

With the thresholds for the basic 20% and higher 40% rates of income tax frozen until April 2028 at £12,570 and £50,271 respectively, and the highest 45% income tax band reducing from £150,000 to £125,140 on April 6, it means more people will either be pulled into the tax system for the first time ever or into higher tax bands as nominal wages increase.

Add in the fact that the annual Capital Gains Tax (CGT) exemption will halve from April 6 (from £12,300 to £6,000) and halve again in April 2024 to £3,000 and the annual tax-free dividend allowance will halve to £1,000 from £2,000 from April 6, and then reduce again to a mere £500 in 2024 - and it’s clear your investments might need a more tax-efficient storage space before allowances dwindle.

With a record 6.1 million* expected to pay income tax at the higher rate of 40% or the additional rate of 45% this tax year, focusing on longer-term savings as well as the everyday bills will become imperative for those looking to reduce the income tax hit.

This figure is likely to jump again next financial year as bumper pay rises push people’s salaries into higher tax thresholds. which is why taking advantage of allowances in tax-efficient investments such as Individual Savings Accounts (ISAs) and pension contributions is now imperative.

Around 792,000 taxpayers will be impacted by the additional income tax threshold reduction, with around 232,000 likely to pay the 45% rate in the 2023/24 tax year who would not have done so had the threshold remained at £150,000.

While the average cash loss for those earning between £125,140 and £150,000, will be £621 in 2023 to 2024, for those earning more than £150,000 the average cash loss will be £1,256.

While maximising tax allowances offered by ISAs and pensions can be a great way to reduce an income tax liability, not everyone has pots of cash sitting around ready to transfer in. This is where the Bed & Isa or Bed & Pension processes might come in to play.

If you hold investments such as shares, funds, investment trusts or exchange traded funds outside a tax wrapper such as in a General Investment Account or an employee share plan, then it might make sense to transfer them into an ISA account because of the imminent changes to the dividend allowance and capital gains tax exemption.

This can be the case for those who have inherited a lump sum or have built up investments elsewhere, perhaps because their ISA was being used to store savings for a house deposit. Savers can shelter up to £20,000 this tax year in an ISA with any income or capital gains tax-free, allowing them to grow wealth and withdraw investments when they want without fear of a hefty tax bill at the end.

To get ahead of tax allowance cuts, which will see investors facing capital gains at much lower levels of profit, investors can sell shares or funds and repurchase them within an ISA – a process known as ‘Bed and ISA’ to keep future returns out of the reach of tax charges.

It’s a sensible move when you consider CGT – which is charged on the profit you make on your investments and is dependent on what asset you are selling and your personal tax status, can be as high as 20% for higher and additional taxpayers and 28% if they are selling residential property. For that reason, anyone who may have made substantial capital gains on their investments outside tax wrappers and has some of this tax year’s ISA allowance left should consider selling up now while they still have the £12,300 tax-free allowance to utilise. If the investments are held jointly with a spouse, it means you have £24,600 to use up this tax year – as opposed to the £12,000 in total at your disposal from April 6.

Similarly, those with dividend-paying assets held outside an ISA might also run the risk of breaching their dividend allowance limit when it halves next year. Dividend tax on the income investors receive from shares, funds or investment trusts is charged at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. The alternative of holding investments in an ISA lets your money compound and grow without the risk of taxation.

Bed & Isa can also be useful because some investors mistakenly assume they can sell their investments and buy them straight back – banking their capital gains and using up the CGT allowance at the same time. However, under UK regulations, investors must wait 30 days to buy back the same investment – a regulation brought in to stop investors carrying out a practice known as ‘Bed and Breakfasting’, where they sold their assets at the end of the tax year to use up their CGT allowance and then brought them back straight after the start of the new tax year.

Bed & Isa is an exception to that rule as the money is being moved into a stocks & shares Isa. Just remember to calculate your capital gain carefully to ensure you don’t make yourself liable for tax.

If you don’t have new money to invest to fill up your annual £20,000 Isa allowance, but do hold other investments, then follow these steps:

Step 1: Open an ISA or top up an existing account

If you don’t already have a stocks and shares ISA, then open one. You can either set it up with the same provider as your general investment account or with a different provider. Remember, while you can have more than type of ISA, you can only contribute to one stocks and shares ISA per tax year.

Step 2: Check your ISA allowance

Those who already have a Stocks & Shares ISA in place and have already made contributions into it this tax year – as well as to any other type of ISA - should calculate how much of their £20,000 they have left.

Go over that figure and you will need to let HMRC know on the ISA helpline 0300 200 3300 and they will advise on the best steps to rectify the situation.

Step 3: Sell your investments, taking care not to breach your CGT allowance

Sell your existing investments held in an investment account up to the value you would like to move into your ISA, making sure you do not exceed your CGT limit of £12,300 in the process.

While you may pay CGT on any profits above your annual allowance, moving the money into an ISA or SIPP means you won’t have to in the future – something that will become very beneficial as allowances dwindle.

Step 4: Move the money / reinvest

If you are moving your investments to an ISA with the same provider, the sale and purchase can be done simultaneously. Remember, your provider may charge a trading fee as well as stamp duty (applicable to UK shares) so take note of those before you proceed. There will almost always be a buy/sell spread between the sale and purchase price, so you could end up with slightly fewer shares in your ISA than you held previously.

If you are moving to another provider, wait for the funds to appear in your investment account as cash then call the new provider and make the transfer to the ISA you hold with them. There is the chance of more price movement between trades in this instance.

Once the funds are added to the ISA, you can then buy back the same investments – effectively ending the Bed & Isa journey. However, savers can also hold the money in cash or invest in a fresh collection of assets.

Don’t worry if you need more time to make an investment selection; simply store your money as cash and then purchase investments as you see fit, or drip feed it into the markets at regular intervals. Some platforms provide interest payments on cash balances, so the money might not be sitting idle.

For those really unsure what to invest the money in, it might be wise to speak to a financial coach for guidance on the next steps.

Some ISA providers have a cut-off point for Bed & ISA transactions – this can be up to a week before the end of the tax year – while others require clients to do the process manually themselves, so allow plenty of time.

An ISA allowance cannot be transferred on to the next financial year, so this really is a case of ‘use it or lose it’ by the April 5 deadline. Remember, everyone has an ISA allowance so for couples there is a double gain as they can squirrel away £40,000 in total (£20,000 each), and don’t forget children can save up to £9,000 in a Junior ISA.

A similar process applies to investments moved into a pension, such as a Self-Invested Personal Pension (SIPP), where a ‘Bed & Pension’ transfer can be utilised. Again, with a limited time window to make use of the more generous CGT allowance, allow several days to complete the Bed & Pension process before the deadline.

Pension saving can be particularly lucrative for those who don’t need to touch their money until they retire because any money invested not only benefits from compounding over the long term but also grows free of any income and capital gains tax. Contributions up to the pension annual allowance also attract tax relief.

While basic rate taxpayers get 20% in tax relief added to their pot with each contribution within the pension annual allowance, those on the higher 40% tax rate get a further 20% and additional rate taxpayers receive a further 25%. For every £1,000 gross contribution paid into a pension by a 40% taxpayer, the net cost to them is just £600 giving their pot a generous £400 bump-up in tax relief.

This makes pension saving undoubtedly the most tax-efficient way of saving money for retirement, something even more key ahead of the tax changes coming into force in just a few weeks. Just remember that unless you are fortunate enough to have adjusted income of over £240,000 a year (and will therefore be subject to a tapered allowance), the annual allowance  you can pay into your workplace or private pension per tax year without having to pay tax on the contributions is 100% of your salary, up to £40,000 gross – a limit that encompasses all contributions across all pension arrangements, tax relief and employer contributions.

If you do choose to Bed & Pension rather than Bed & ISA, remember, once the money is added to your pension, you cannot touch it until you are 55, or 57 from 2028.  Plus, go over the pension annual allowance and you risk incurring a tax charge. Thankfully, you can carry forward any unused annual allowance from the previous three tax years. So, consider using up your allowances in the run up to the end of the tax year in April, particularly if you are a higher earner.

* According to HMRC

This does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.

The value of an investment, and the income from it, may go down as well as up and you may get back less than you originally invested.

Examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief (if applicable) will depend upon individual circumstances and may be subject to change in the future.