What is “Bed and ISA” and should you do it before the Autumn Budget?

Disgruntled investors are having to hand over more of their money to the taxman after the dividend and capital gains tax allowances were slashed again earlier this year. What’s more, it is possible that chancellor Rachel Reeves will have more bad news for them when she delivers her Autumn Budget on 30 October.

Against this backdrop, “Bed and ISA” transactions are becoming increasingly common as investors look for ways to protect their dividends and cut their capital gains tax bill. This type of transaction involves transferring existing assets into an ISA wrapper where any future capital growth or income will be sheltered from the taxman. 

Investment platform Interactive Investor recently reported that it has been its busiest summer ever for “Bed and ISA” transactions, with activity up 27% between 1 June and 31 August compared to the same period a year ago. Transactions are up 99% compared to the summer of 2022.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

AJ Bell also reports a spike in the past couple of years – a period which has seen the capital gains allowance cut progressively from £12,300 to £3,000, and the dividend allowance cut from £2,000 to £500. 

It comes as speculation mounts that Reeves could hike capital gains tax (CGT) at the upcoming Budget to help fill the £22 billion shortfall in the public finances.

Capital gains are currently taxed at a lower rate than income, and some experts have argued that this makes little sense.

“The government could align CGT rates with income tax, as recommended by the Office of Tax Simplification in 2020, or opt for another change to the CGT regime,” says Myron Jobson, senior personal finance analyst at Interactive Investor. 

“Regardless of what is announced in the Budget, shifting existing investments into a tax-efficient wrapper like an ISA or a SIPP can pay dividends – which, over the long term, is likely to outweigh any charges that might apply,” he adds.

How to cut your tax bill with “Bed and ISA”

ISAs are a tax-efficient way to save, and all adults have a £20,000 tax-free allowance which resets every year. Returns made in an ISA are not subject to capital gains tax, no matter how much you earn. Dividends received in an ISA are also shielded from the taxman. 

But what about the investments you hold outside of this tax wrapper? 

Some years, you might use up your entire ISA allowance and still have some money left over to invest in a regular stocks and shares account. If these investments generate any income or capital gains, you will owe money to the taxman and will need to declare this by completing a self-assessment tax return. 

Basic-rate taxpayers pay 10% CGT on investment gains and 18% on gains from the sale of additional residential properties. Meanwhile, higher and additional-rate taxpayers pay 20% on investments and 24% on second properties. The CGT allowance means some profits are tax-free but, as introduced previously, this has been slashed in recent years from £12,300 to £3,000.

Meanwhile, dividends are taxed at 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers. The dividend allowance is now only £500, after being halved in April 2023 and again in April 2024. 

As this shows, assets held outside of an ISA can quickly rack up a hefty tax bill. The latest HMRC data shows that the taxman collected £14.4 billion in CGT during the 2022/2023 tax year alone.

However, the good news is that a “Bed and ISA” transfer can help you hang onto more of your money in years where you haven’t used up all of your £20,000 allowance on new investments. We take a closer look. 

How does “Bed and ISA” work?

A “Bed and ISA” strategy works by selling your existing investments and repurchasing them back within an ISA. Your provider will sell your investment on the open market and then move the money into the tax-efficient wrapper.

Crucially, by selling existing assets and realising gains of up to £3,000, you can stay within your annual CGT allowance. “That way you can use your CGT allowance to realise gains, and simultaneously protect this slice of investment from CGT for good,” says Sarah Coles, head of personal finance at Hargreaves Lansdown. 

She adds: “The reasons for the ridiculous name are buried in a trick that investors could use until 1998, called Bed and Breakfast, when they could sell assets, crystalise the gain for CGT purposes, and then immediately buy the same assets back. 

“The rules were changed so that you now have to wait 30 days before buying back in – or invest in something else. However, selling up outside an ISA and buying back immediately within the tax wrapper remains an exception to this rule.”

Not all trading platforms offer a “Bed and ISA” service and it is only an option if you still have some of your annual £20,000 ISA allowance remaining. What’s more, if you realise capital gains of more than £3,000 when you sell your original investments, you will need to declare this to HMRC and pay tax on the excess.

Finally, it is important to bear in mind that there are some costs associated with a “Bed and ISA” transaction. Although you won’t typically pay a fee on the initial sale of the asset, you will have to pay a fee when the investments are repurchased.

You may also need to pay stamp duty (0.5% of the transaction value) and may lose a small amount if the repurchase price differs from the sale price.

Should you carry out a “Bed and ISA” transaction before the Autumn Budget?

Although taxes could go up in the Autumn Budget, investors don’t necessarily need to rush into a decision before 30 October. When a government announces tax hikes, they typically come into effect at the start of the new tax year. This would give investors several months to assess the impact of any new policies before making an informed decision. 

Of course, it is also possible that the government won’t hike CGT after all. “The government’s own figures show that a big increase in CGT rates could backfire and actually lead to lost revenue,” says Laura Suter, personal finance director at AJ Bell. 

“For example, raising both the lower and higher CGT rates by 10 percentage points, to 20% and 30% for non-property gains, would result in a total loss of £2.05 billion for the Exchequer by 2027/28,” she adds. “That’s because while the rates are higher, investors would be expected to change their behaviour to mitigate paying the tax.”

Nevertheless, if you have any leftover ISA allowance, a “Bed and ISA” transaction could be worth considering to reduce your tax burden. What’s more, acting sooner rather than later could bring your overall bill down for the 2024/2025 tax year, as you are likely to accrue more income (and hopefully more capital gains) as the year progresses. 

See our analysis on why early bird ISA investors usually fare better than their last-minute counterparts: “Early bird vs last-minute ISA investing”.