Tax has somewhat of a reputation for being difficult to understand, perhaps because of the many different rules and regulations involved and the sometimes small but important ways they can change from one year to the next.
Taxes on savings, investments and earnings all come with bands, reliefs, allowances and exemptions. Knowing how to maximise your tax efficiency during each financial year is a key part of financial planning.
The 6th April marked the start of the new 2021/22 tax year and, with this in mind, we’ve outlined five areas for consideration, when looking at ways to make your finances and investments more tax efficient.
1. Make efficient use of your personal allowance
The personal allowance i.e. the amount you can earn before paying income tax, rose to £12,570 on 6 April 2021. The higher-rate 40% tax band threshold also increased to £50,270.
For Scottish Taxpayers there are starting rate, basic rate and intermediate rate bands and then the higher rate 41% tax band starts at £43,430.
Higher earners begin to lose their personal allowance however, when they earn over £100,000. Their personal allowance is reduced by £1 for every £2 of income above this threshold and thus their allowance is zero if their income exceeds £125,140.
Bob Bradley, Independent Financial Adviser, Ascot Lloyd, comments that a lot of people will be aware that they get tax relief on pension contributions, but they might not be aware that you can use pension contributions to bring gross income below the 40% or 45% tax bands.
The Chancellors Spring Budget which kept allowances static for 5 years has created a fiscal drag effect. Fiscal drag is where inflation and earnings growth may push more taxpayers into higher tax brackets. Therefore, fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.
2. Make use of your tax-free pension allowance whilst being mindful of the lifetime allowance
The annual allowance i.e. the limit on the amount of pension contributions that can be made each year and qualify for tax relief is £40,000. This, however, may be lower depending on an individual’s personal circumstances, as tax relief is limited to 100% of earnings and the annual allowance can be restricted to £4,000 for higher earners.
When it comes to deciding how much you should save into your pension, it is also important to be aware that there is a limit on the size of overall pension savings you can accumulate without facing a tax charge. This is known as the Lifetime Allowance and if you exceed this this amount, a tax charge will arise at either 25% or 55%, dependant on how the excess is taken. The lifetime allowance for 2021/22 is £1,073,100 and like other allowances is set to remain at this level until the 2025/26 tax year.
Did you know... you can carry forward 3 years worth of unused pension tax relief?
If you haven’t paid into your pension for the previous 3 years, you may be able to place up to £120,000 into a pension without exceeding your annual tax-free allowance. For example, if you have inherited a large sum of money, placing it into a pension could be a tax efficient option to consider. We would always recommend obtaining advice from your Ascot Lloyd Independent Financial Adviser on this matter however, as it is a complex area.
3. Don’t wait to benefit from tax-free returns relating to your ISA allowance
For the 2021/22 tax year, the Individual Savings Account (ISA) annual subscription limit remains at £20,000 and the annual allowance for Junior ISAs and Child Trust Funds is £9,000. By making use of these allowances earlier rather than later in the tax year, your investments will have the chance to benefit from tax-free returns for longer.
Bob Bradley explains that for some clients where they have dividends arising from their General Investment Accounts and share portfolios in excess of their dividend allowance of £2,000, the sooner they set up an ISA for up to £20,000 each, for both the husband and wife, the greater the tax saving will be.
4. Reduce your exposure to capital gains tax
The ‘annual exempt amount’ for capital gains tax, which has been frozen at £12,300 for the next 5 years, is an allowance frequently overlooked by many people.
This is often applicable to property portfolios, but Bob Bradley explains that if you have a large portfolio of shares or collective investments held outside an ISA or other tax wrapper, it’s worth using as much of your capital gains tax allowance as possible each year. By selling assets that have risen in value you can mitigate your exposure to capital gains tax for the future.
5. Gifting allowances: use them or lose them
Did you know that you can give away up to £3,000 worth of gifts, which can be assets or cash, each tax year and they will be immediately excluded when calculating the value of your estate? This is something worthwhile considering if you are looking to reduce your estate for inheritance tax purposes. Known as the annual exemption, this amount applies to individuals, so a couple can make £6,000 worth of gifts in total each year. This exemption can also be carried forward for 1 year so if it was not used last year, a married couple could gift £12,000 in this tax year.
Don’t forget... you can make larger gifts than your annual exemption and these ‘potentially exempt transfers’ (PETs) will be free of IHT as long as you live for more than 7 years from the date of the PET.
Bob Bradley explains that he’s finding that as a population which is living longer, ‘children’ who are in their late 60’s or 70’s are suddenly inheriting monies from their parents in their 90’s. This is often too late, and the financial help would have been useful many years earlier. More and more of his clients are wanting to help family when they really need it, for example buying a first home or paying for weddings, and this is where PETs can be very attractive. It’s worth remembering that the earlier gifts are made, the greater the chance that the donor will survive 7 years.
At Ascot Lloyd, we are here to help you work through all of the things you need to consider as part of your financial plan. If you would like to find out more about any of the areas outlined above or are interested in receiving some advice, please don’t hesitate to contact your financial adviser.