As we approach the end of the tax year, it’s the ideal time to check your finances are healthy and ready for the next chapter – whatever that brings!
We’ve been living through exceptional times, and a lot of history has been written recently, including record levels of peacetime Government borrowing to fight the pandemic and help businesses and individuals1. As a result, this year’s tax planning will be undertaken in the context of media speculation that the upcoming Budget on 3rd March 2021 will result in some changes to personal taxes2.
We will write again then to update you and analyse the implications for investors. In the meantime, one way to ensure your finances are arranged tax efficiently is by making use of the current allowances. This article outlines several ways to achieve this.
We recommend that you should always speak to a financial adviser to ensure that any actions are appropriate for your own circumstances.
The ISA allowance of £20,000 for 2020/21 provides a great opportunity to save or invest in a tax-free environment. A contribution could be funded from cash or by recycling investments from a general investment account, potentially also making use of the capital gains tax (CGT) allowance.
Younger people (generally speaking, those aged under 50), including those saving for their first home, could also benefit from the Government top-up associated with saving in a lifetime ISA. Subject to certain criteria being met, the Government pays an additional 25% on the amount invested up to a subscription allowance of £4,000 in this tax year (which forms part of the overall £20,000 allowance).
Finally, provision for children under age 18 could be made by using a junior ISA. The junior ISA allowance was increased generously for this tax year and is currently £9,000. By contributing as, for example, a parent, access to the funds is given up, but control is retained over how it is invested. Once the child reaches age 18, the account turns into an adult’s ISA and becomes the child’s property outright.
Pension saving is extremely tax efficient. Generally, contributions benefit from income tax relief, growth within the fund is tax free, there is a 25% tax-free cash entitlement on retirement and funds are outside of an estate for inheritance tax (IHT) purposes.
In this tax year, up to 100% of an individual’s UK earnings can be contributed to a pension to receive tax relief, subject to the annual allowance of £40,000. Unused allowances from the preceding three tax years can potentially be ‘carried forward’ to be used in this tax year.
However, this is a complicated area, with important considerations for those who have drawn income from their pension and those whose income exceeds £240,000. Those with larger pensions must also consider the lifetime allowance (currently £1,073,100), which has further issues for people with a protected lifetime allowance that could be lost if certain criteria are not met.
Capital gains annual exempt amount
In 2020/21, CGT may be payable on capital gains realised above the exempt amount of £12,300. The CGT rate on investments is 10% for basic rate and 20% for higher/additional rate taxpayers. For gains made on the sale of properties other than a primary residence, the rates are higher at 18% and 28%, respectively.
Selling investments up to the exempt amount could save CGT of up to £4,920 for a couple who are both higher rate taxpayers, potentially enabling them to rearrange funds in their portfolio or to generate funds to use their ISA allowances.
Philanthropic donations benefit both the donor and recipient. Many people are familiar with Gift Aid, and potentially another very efficient way to give to charity is to gift investments.
The value of the donation is deducted from taxable income, exempt from CGT and immediately outside of an estate for IHT purposes.
Gifts of up to £3,000 per year are exempt from IHT. Once the current year’s allowance has been used, any unused allowance from the previous tax year can be carried forward, potentially meaning a gift of up to £6,000 could be made without incurring IHT.
Gifts out of surplus income are also exempt, provided they meet certain criteria.
Income tax personal allowance
Those with income between £100,000 and £125,000 suffer an effective tax charge of 60% on this slice of income as the personal allowance for income tax is gradually removed. Making pension contributions or gifting to charity can help to reclaim the personal allowance, lowering the overall tax paid.
Further, higher risk options that might be considered, once other allowances are used, are Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS). These schemes offer tax incentives to encourage investment into smaller UK companies. On top of income relief of 30% (50% for SEIS), VCTs benefit from tax-free dividends, while EISs can be used to defer a CGT liability and may qualify as IHT-exempt if held for two years.
These investments are generally only suitable for certain individuals who can afford to take a high level of risk with their capital and are seeking to invest for at least five years.
Whatever your circumstances, it’s the perfect time to consider your options. As always, do contact your adviser if you’d like to discuss your planning for the end of the tax year.
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Please note that any thresholds, allowances, percentage rates and tax legislation stated may change in the future. The content of this communication is for your general information and use only; it is not intended to address your particular requirements. This communication should not be deemed to be, or constitute advice. You should not take any action without having spoken with your usual adviser.