What is Bed and ISA and why you should do it

The end of the tax year is rapidly approaching, which means it’s nearly ISA season. And with taxes going nowhere but up, it’s more important than ever to make the most of your cash or stocks and shares ISA allowances.  

One way of capitalising on your annual stocks and shares ISA allowance is to use the so-called bed and ISA process. This involves transferring assets held outside of a tax wrapper into an ISA so any future capital growth or income on these assets is sheltered from tax.

Capital gains and dividend tax allowances are both shrinking from April 2023, and investors appear increasingly focused on tax planning to preserve wealth. 

Investment platform interactive investor recorded a 206% increase in Bed & ISA applications in February alone compared to a year ago, the biggest year-on-year monthly rise since the Autumn Statement, but application numbers have been increasing since November. 

The clock is ticking on bed and ISA applications as most platforms usually have a cut-off point, usually a week or so before the tax year ends. 

Although this strategy has some disadvantages, it could be worth considering as the Treasury clamps down on tax breaks available to investors. 

The benefits of a bed and ISA switch 

There are four different types of ISAs, cash ISAs, stocks and shares ISAs, innovative finance ISAs and Lifetime ISAs. 

Cash ISAs and stocks and shares ISAs are the most popular because they are the most flexible. You can put up to £20,000 per tax year into one of these wrappers and you don’t need to pay any tax on interest income, dividends or capital gains earned on this money - you don’t even need to declare the ISA on your tax return. 

Savers can easily transfer their assets from a cash savings account into a cash ISA. It’s a little harder for stocks and shares ISA investors to do the same if they want to lower their tax liability. 

One strategy is to use the so-called bed and ISA switch. 

This strategy involves transferring assets held outside of a tax wrapper into an ISA, and is usually organised by your broker. The broker sells the investments held outside of the wrapper for you (as long as they’re held on the same platform), transfers the cash, and then buys back the same assets within a stocks and shares ISA. 

Not all trading platforms offer this service, so it’s worth checking with your provider before going ahead. 

There are some costs associated with the transaction. Customers won’t pay a fee on the initial sale cost of the asset, but they will pay a fee on the re-purchase in the ISA wrapper. 

Investors will also need to pay stamp duty (0.5% of the transaction value) and may lose a small amount if the re-purchase price differs from the sale price. 

There’s also capital gains tax (CGT) to consider. 

Myron Jobson, senior personal finance analyst at interactive investor, says: “Shifting investments into an ISA protects future gains and dividends from the clutches of tax. It also means that you will no longer have to declare them on your self-assessment tax return. Bed & ISA is also a valuable tool as a part of a broader portfolio spring clean strategy.”

“There might be CGT implications, depending on your circumstances as Bed & ISA action is treated as a sale for CGT purposes,” Jobson adds. “This means that gains that exceed the current annual CGT allowance is liable to tax.”

Still, when assets are in a stocks and shares ISA you won’t need to pay any tax on those assets in future. 

So while there could be tax implications at the time of the sale, the long-run benefits could be significant. 

Why ISAs are becoming more appealing

The benefits of using ISAs to save and invest are becoming more attractive by the day. 

With taxes for investors and savers set to go up over the coming years, the tax-free nature of these products is only becoming more attractive. 

For investors, the capital gains tax threshold will fall in April 2023 from £12,300 to £6,000 and then again to £3,000 in April 2024. Meanwhile, the dividend tax threshold will also be reduced from April from £2,000 to £1,000 and £500 in April 2024. 

At the same time, savers will be hit in the pocket by rising interest rates and frozen tax bands. 

Analysis by the Telegraph shows that one million savers will have to start paying tax on their savings income this year as a result of “a stealth raid” by the Treasury. Basic rate taxpayers have a £1,000 tax-free allowance on savings interest, which was introduced in 2016. Higher-rate taxpayers have an allowance of £500. 

A tax-free allowance of £1,000 was quite a lot when it was introduced in 2016 when the Bank of England base rate was 0.25% but today, with interest rates at 4% it’s causing a headache for savers. 

Indeed, according to an analysis from Consultancy LCP in 2016 when the allowance was introduced, a basic rate taxpayer with £100,000 in NS&I income bonds with an interest rate of 1%, wouldn’t have had any tax liability. Today, the same saver with £100,000 of bonds would be earning 3.9% or £3,900 a year in interest. The tax liability on this income would be in the region of £580. 

“A bitter cocktail of tax freezes and some reduced allowances mean that while headline tax rates haven’t risen, we’ll be paying more in tax over the coming years,” says Jobson.

This is where cash ISAa and stocks and shares ISAs can play an important role for investors and savers.

“The impending swingeing cuts to the CGT and dividend tax threshold provides the impetus for investors to invest through a tax efficient wrapper if they haven’t already done so,” notes Jobson.

“Shifting investments into an ISA protects future gains and dividends from the clutches of tax. It also means that you will no longer have to declare them on your self-assessment tax return.”