To determine which tax wrappers may be most appropriate for a particular client, it’s important to understand in what order an individual will be taxed on different types of income and gains in the UK.
Wrappers unwrapped: Understanding the order of tax
How income and gains are taxed
Broadly, the first slice of a person's income comprises their earnings, pensions, taxable social security payments, trading profits and income from property. The next slice is savings income then dividend income. Gains are calculated last. Each of these qualifies for allowances that effectively enable the first tranche of returns to be taken free of tax, subject to certain rules.
Taxable income includes the full amount of insurance bond gains. All bond gains are savings income. If it is an onshore bond gain, the gain is treated as the highest part of total income i.e. taxed after dividends. If the gain is from an offshore bond, it comes before dividend income.
Where there is a bond gain and a capital gain in the same tax year, the capital gain is ignored when calculating the tax due on the bond. However, when calculating the CGT liability, the top-sliced bond gain is included as income when determining the rate of capital gains tax payable.
Issues to consider
- Is a client (and any spouse) making full use of their personal, savings, and dividend allowances?
- Is the client’s tax wrapper allocation being reviewed alongside their asset allocation?
- Would their capital gains annual exempt amount provide a useful source of tax-efficient return?