Ideas To Reduce The Effects Of A Wealth Tax

Takeaways

• What is a wealth tax

• Find out what allowances you can use

• Tax efficient choices

What is a wealth tax?

A wealth tax can come in two forms, a one off line in the sand: everyone who earns above a certain threshold will pay a one off fee, or a change in a tax rate. The furlough programs have led to a further stretching of already stretched government budgets, who are increasingly looking at the wealthy to fund the shortfall.

After a monumental market rally since the Covid caused sell off in March 2020, governments sense they can get away with taxing the wealthy. This is on the basis that the wealthy have been the biggest beneficiary of the various schemes launched - in this case quantative easing.

There are already examples of governments creating a wealth tax. Russia is instituting a levy on interest earned for balances over 1 million Rubles. In the UK, the British Chancellor has asked that HM Treasury investigate how capital gains are taxed for both individuals and smaller businesses. As a rule, a review of tax by a government usually leads to an increase. This is not the end of the world. Often governments will also give tax breaks.

Take your free lunch

Most governments will offer some form of tax-saving allowance. For high earners, pensions are a great way to shield your wealth from a wealth tax, as governments are increasingly keen for people to save for their retirement so as to reduce the burden on the state.

The UK is famous for it's ISA, which shields £20,000 per year from tax, and is very generous, but the Canadian Tax-Free Savings Account (TFSA) is also attractive. In particular if you do not use up your entire allocation in years gone by, you can roll them into next year(s).

Incorporate tax planning when investing

Although you should not plan investment decisions on tax efficiency, it helps to be aware of the effects. If you prefer investing in funds and ETFs, you are often presented with the choice of buying accumulating (ACC) or income (INC) shares.

Do not let the tax tail wag the dog.

The difference is that ACC will reinvest any dividends within the fund, i.e. no income is paid to you, and no tax event is created. INC shares will pay income, which may lead, depending on your personal tax circumstances, to tax on this income.

From a tax efficiency perspective, capital gains tax is often cheaper than income tax. Dividends paid by INC shares are liable for income tax, whereas if you have no need for income, ACC shares can be sold every so often at a lower (capital gains) tax rate.

Actively manage your portfolio

In the UK the Capital Gains Tax (CGT) allowance of £12,300, means you will not pay any capital gains unless you profit above this level. Holding on to a share which then creates a gain of £50,000, is a wonderful investment return. Problem is, this is not so spectacular an overall return when you have to pay CGT on £37,700!

Approaching your stock portfolio with discipline will also help with a wealth tax. If you have a holding which has benefited from momentum investing and has outperformed spectacularly, (such as big tech?) why not reduce it a little?

You would bank some gains, protecting yourself from the downside risk of a profit warning or other any disappointment in the shares and potentially pay no tax as you keep your profit taking within your CGT allowance.

Conclusion

Tax can be a big problem for capital preservation, as like any cost, it reduces the growth of your portfolio. Governments are already taxing you through stamp duty on shares, but now it seems they are keen to increase taxes in other areas too.

Although their reasons seem honorable, to cover the costs of the various job furlough schemes, it is possible to negate the effect on any future tax increases. Fundamentally, it requires finding out the facts and then adjusting your investment strategy. If you can use available options, you should be able to reduce the effect of a wealth tax.