New tax year, new allowances
Whether you’re a seasoned pro at maximising your tax allowances every year, or if you are finally brave enough to pull your head from the financial sand, the start of the new tax year (6th April) is a good time to understand what allowances you have and how best to use them.
Entry level tax planning is paying into an ISA up to your annual £20,000 ISA allowance. You can use this for cash savings or your investments, and the main benefit of an ISA is that growth, income and withdrawals are all tax-free.
You can also pay £9,000 into a Junior ISA (JISA) for your children every year, which they can access at age 18. Or if you have children age 18-39, who are saving for their first property, you can help them pay into a Lifetime ISA (LISA) which gets a 25% bonus from the government. LISA contributions are capped at £4,000 per year (£5,000 including the bonus) and makes up part of an individual’s £20,000 ISA allowance. A point to note is that a LISA can only be accessed penalty-free when used to fund a first-time buyer’s home deposit or after age 60.
Capital gains tax allowance
Capital Gains Tax (CGT) is effectively just tax on the profit you make on assets you sell, most commonly shares, investment funds and second properties (your home is exempt). The annual CGT allowance is £12,300. Any profit you make within this allowance is tax free and any profit above this level is subject to CGT at 10% - 28%, depending on your level of earnings and the type of asset sold.
Transfers of assets between spouses are free from CGT (the main reason people get married supposedly). So, if you are selling shares that will crystallise a profit above your CGT allowance, rather than paying tax on the excess you can transfer some of the shares to your spouse, CGT-free, who would sell them using their CGT allowance as well. Similarly, if you are selling your holiday home and it is owned solely by you, moving the ownership to joint names with your spouse means that the profit would be split equally between you, using both of your CGT allowances and spreading the tax between you. It’s even better if your spouse earns less than you as the tax rate on their share could be lower.
The most common use of the CGT allowance for our clients is selling down their taxable investments every year and moving the proceeds into their tax-free ISA, therefore using their ISA allowance.
Stepping it up a gear, you also have pension allowances you can use every year. Although ignored by most people, pension contributions are a fantastic way to save for retirement. Not only are the investments within your pension free from income tax, capital gains tax and inheritance tax, but pension contributions allow you to effectively claim back any income tax you’ve paid on the payment amount, known as tax relief. For example, if your salary was £70,000, your highest tax rate would be 40% (41% in Scotland), which means that a £10,000 pension contribution could cost you as little as £6,000 (£5,900 in Scotland). 20% tax relief is added by your pension provider and higher/additional rate tax relief can be claimed from HMRC.
With the 2020 median salary being £31,461 in the UK¹, pension contributions that qualify for tax relief for most people are capped at their salary. This is because you can effectively only re-claim tax that you’ve paid. However, if your annual earnings are above £40,000, your contributions are capped at £40,000 per year – this is known as the ‘annual allowance’. If you have any un-used annual allowance from the previous three tax years you can use this as well, but you can only reclaim tax paid in the year the contribution is made.
Even if you don’t have any earnings, you can still get tax relief on pension contributions up to £2,880 every year, which is topped up to £3,600 by the pension provider (20% tax relief). This allowance is more commonly used for paying into a pension for a child, homemaker or retiree.
To finish up on pension contributions, the expert level pension allowances to be wary of are the money purchase annual allowance (MPAA) and tapered annual allowance (TAA). The MPAA is £4,000 and applies if you have ‘flexibly accessed’ your pension but would like to pay in more (replacing the standard annual allowance). The TAA applies to those earning above £240,000, which can reduce your annual allowance from £40,000 down to as low as £4,000.
In addition to limits for paying into your pension, there is also a limit on how much you can take out before facing a tax penalty, called the ‘lifetime allowance’. The lifetime allowance is currently just over £1million (£1,073,100) and will stay at this level until 2026. The tax charge ranges between 25% - 55% depending on when and how the excess is tested against the lifetime allowance.
As you can probably tell, given the complexity of pensions outlined above, people are usually put off. But if you have cash to invest that you won’t need until at least age 55, have pension savings that could be close to the £1million mark in retirement or think the MPAA/TAA applies to you, you should get advice on what to do next. Not only could you avoid a hefty tax bill, but you could also significantly boost your retirement savings and the tax-efficiency of your investments.
In any case, you should get advice on any tax planning or pension contributions, as the rules can change regularly, and a financial planner should be able to help you keep on top of the changes and what they mean for you.
Last but not least
ISA, CGT and pension allowances are the most commonly used for our clients, but you should also consider the:
- Personal allowance (£12,570): as well as earnings and savings, pension income within this allowance is paid tax-free, so if your annual income is below this level you could look into taking more from your pension to utilise the full tax-free amount.
- Marriage allowance: on the other hand, if you are not using your full personal allowance and your spouse is a basic rate taxpayer, you can transfer up to 10% of your un-used personal allowance to them, which can save around £250 in tax every year. This allowance can be backdated four tax years (at the point of writing, to 2017/18), so a potential tax refund of over £1,000.
- Gift allowance (£3,000): if inheritance tax is a concern for you, gifts of up to £3,000 in total per tax year will fall out of your taxable estate immediately, instead of being subject to the seven-year clock. You can use any un-used allowance from the previous tax year as well.
- Dividend allowance (£2,000): if you own a limited company, taking dividends within this allowance is a tax-efficient way of drawing an income, alongside salary and employer pension contributions. This allowance also applies to dividends paid from your investments.
Definitely a lot to think about but the good news is that you have a whole year to work your way through these allowances (cue last minute panic at the end of March..). With holidays abroad likely to be off the cards again this year, this could be a good way to utilise your spare cash.
A key part of our work at 7IM is ensuring that clients maximise the tax-efficiency of their investments and financial affairs, so don’t hesitate to get in touch if you need help or if you would like further information.
¹ Office on National Statistics, 2020: https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/bulletins/annualsurveyofhoursandearnings/2020
The steps highlighted in this press release are intended as a general guide only. The information contained in this document does not constitute investment or tax advice. Tax rules are subject to change and taxation will vary depending on individual circumstances.