Alice Guy explains how to use this often overlooked rule to reduce your tax bill and boost your investment wealth.
With the tax year-end nearly upon us, it’s easy to focus on using our ISA allowance and lose sight of the tax benefits pensions can bring. But using a pension can provide even more benefits than ISA investing when it comes to building long-term wealth.
And with the tax rules changing, it's important to make use of the existing capital gains exemption before it is cut in April.
Here we explain the Bed and SIPP rules and how to use them to save tax and boost your retirement income.
What is Bed and SIPP?
Bed and SIPP works just like Bed and ISA: it’s when you sell some of your existing stocks and shares investments and rebuy them inside your SIPP.
The investments you buy inside your SIPP count as a normal pension contribution, so you’ll need to watch out in case you breach the pension annual allowance, which is currently £40,000, up to the maximum of your taxable income each tax year.
The benefits of Bed and SIPP
Using a Bed and SIPP means that more of your investments will be protected from tax inside a pension wrapper and can grow free of dividend income tax and capital gains tax.
When you make a pension contribution, you’ll also benefit from tax relief, giving your pension contribution an additional boost. This tax relief makes a big immediate difference to your investment wealth and means if you contribute £80 to your pension, the taxman will boost it by £20, taking your total contribution to £100. In addition, higher-rate taxpayers can claim an extra 20% tax relief through their tax return, or by writing to HMRC at the end of the tax year. Additional rate taxpayers can claim an extra 25%.
There are also potential inheritance tax benefits to pension saving, as anything you leave to beneficiaries in your SIPP will be outside your estate for inheritance tax purposes.
Act now before tax year end
The CGT and dividend tax rules are changing in April, a change which will make pension and ISA investing even more attractive.
Any stocks and shares held outside a SIPP or ISA are subject to capital gains tax (CGT) and dividend tax: the annual exemption for CGT is plunging from its current level of £12,300 to £6,000 in April 2023, and to £3,000 in April 2024. Likewise, the annual exemption for dividend income is falling from £2,000 to £1,000 in April 2023, and to £500 in April 2024.
You need to act now if you want to take advantage of the current tax allowances before they are reduced in April. For example, you could sell some shares, keeping your gains below the current CGT exemption of £12,300 and rebuy them within a SIPP or an ISA.
The tax changes mean that even small investment portfolios could now attract a big tax bill in the future. For example, an investor with a portfolio of £50,000 held outside an ISA or SIPP and £2,000 dividend income would currently pay no dividend income tax, but would owe £38 dividend tax next year and £506 dividend tax the following tax year.
The tax benefits of SIPP or ISA investing mount up over time. A higher-rate taxpayer with £300,000 investment wealth and annual dividend income of £12,000 could end up paying £3,881 dividend tax each year, or around £49,000 over 10 years, assuming 5% investment growth.
Selling some of this portfolio and reinvesting it inside a SIPP could reduce the investors’ tax bill significantly in the future, especially as their investment wealth grows.
Potential pitfalls of Bed and SIPP
Before taking action, you need to watch out for certain potential pitfalls from moving your investments into a SIPP.
First, you will need to sell your investments and could therefore trigger a capital gains tax charge. Any gains over the CGT allowance are added to your taxable income and tax is charged on the gain at 10% if you’re a basic-rate taxpayer and 20% if you pay higher-rate tax. You could minimise this charge by gradually selling your investments over several tax years to keep your gains below the exempt amount.
Second, as mentioned above, your pension contributions will count as a normal pension contribution, so you’ll have to stick within your annual allowance - £40,000 up to your taxable income for most people, or £4,000 if you’ve already started drawing a pension income.
Third, it’s important to understand pension rules, as investing in a SIPP may not be a suitable if you need to access your investment wealth in the short term. The minimum state pension age is currently 55, rising to 57 in 2028, and then gradually rising as the state pension age increases.
- Minimum private pension age could be rising to 58
- State pension age shock as big changes likely sooner than planned
Fourth, you may also have to pay income tax when you come to draw a pension income, although you’re currently allowed to withdraw 25% of your SIPP fund tax-free. Withdrawals after that initial tax-free amount are taxed in the same way as other income, although pension income is currently free from National Insurance.
In contrast, if you pay into an ISA, you’ll have no income tax to pay when you draw money out, however, you won't get extra tax relief when you pay in.
How to Bed and SIPP
Here are the steps if you want to perform a Bed and SIPP on the ii platform:
1) Sell the investments you want to move into your SIPP: you’ll have to pay standard commission when you sell your investments.
2) Once you have cash in your trading account, you can top up your SIPP with a pension contribution.
3) Once your pension contribution is in your SIPP, you can buy the same investments or pick something completely different, it’s up to you.
Also consider Bed and ISA
If you want to protect your investments from CGT and dividend tax, you could also consider a Bed and ISA.
This works in the same way as Bed and SIPP, but ii takes care of some of the steps for you. All you need to do is select Bed and ISA from the cash & transfers menu, choose the investments you want to move to your ISA, and we’ll take care of the rest.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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Important information – SIPPs are aimed at people happy to make their own investment decisions. Investment value can go up or down and you could get back less than you invest. You can normally only access the money from age 55 (57 from 2028). We recommend seeking advice from a suitably qualified financial adviser before making any decisions. Pension and tax rules depend on your circumstances and may change in future.
Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.