For financial planning and investment management advice
17 Feb 2020
Could you improve your tax efficiency?
With tax rises thought to be imminent, it could be even more beneficial to use current allowances efficiently as part of your financial planning. Here are some steps to take ahead of the new tax year which begins on 6 April.
Check you’ve maximised your ISA allowance
The Individual Savings Account (ISA) is a tax-free wrapper in which your investments are held. The maximum amount you can save tax-free in an ISA for the 2020/21 tax year is £20,000 per person. Your allowance can be invested into a Cash ISA, a Stocks & Shares ISA or a combination of the two.
Anyone aged 16 or over is allowed to have an ISA invested in cash. Anyone over the age of 18 can have an ISA invested in any combination of cash and shares. Some ISAs are flexible: this means you can take cash out of the ISA and then put it back in during the same tax year without reducing your year’s allowance. It is advisable to check the terms and conditions of the ISA provider before making withdrawals.
The Lifetime ISA (LISA) is available for people aged between 18 and 40 to save towards buying a first home, or alternatively it can be withdrawn after the age of 60. You can put in up to £4,000 each year, which will form part of the overall £20,000 ISA allowance, until you are 50. The government will add a 25% bonus to your savings, up to a maximum of £1,000 per year. Any withdrawals from the LISA that are not put towards purchasing your first home before the age of 60 will incur a penalty of 25% of the value of the withdrawal – therefore losing the interest applied.
The Junior ISA is available to UK residents aged under the age of 18 who do not have a child trust fund account. The allowance is £9,000 in tax year 2020/21.
With so many different options available, it is prudent to review your arrangements regularly, to ensure that both you and your family are optimising your use of ISAs. If you do not use your ISA allowance, you are not able to use it in subsequent years.
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2. Consider putting more into a pension
A pension is a wrapper that allows for tax efficient investing, with tax relief on contributions and tax-free growth. The annual allowance (the maximum allowable contribution which is eligible for tax relief) is £40,000. You can also utilise unused annual allowances from the previous three tax years, subject to certain rules, which provides further scope for making contributions.
High earners should be aware that their annual allowance may be restricted.
If you have taken pension income via flexi-access drawdown or uncrystallised funds pension lump sums, you will be subject to the Money Purchase Annual Allowance (MPAA). Once the MPAA has been triggered, you will only be able to make annual tax relievable pension contributions of £4,000.
3... especially if you have earnings in excess of £100,000
If you earn over £100,000, making pension contributions is highly advantageous. Your personal allowance is reduced by £1 for every £2 of income above £100,000, meaning that someone with adjusted net income of £125,000 would have no personal allowance in 2020/21. However, if you make a pension contribution, you are able to offset the reduction in your personal allowance.
4. Use your current Capital Gains Tax allowance
Capital Gains Tax (CGT) is payable if you sell or dispose of an asset. In tax year 2020/2021 the annual tax free allowance is £12,300, meaning you can make gains up to this amount and not pay CGT. Losses can be offset against gains but unused allowances cannot be carried forward. Assets may potentially be transferred between spouses allowing you to utilise both your allowances, which would give married couples a total allowance of £24,600 in tax year 2020/21.
CGT is currently under review with changes likely to be introduced in 2021 or 2022. The CGT allowance could be reduced to between £2,000-£4,000 with the rate that is payable on assets (10% for a basic tax payer or 20% for a higher rate tax payer) and property (18% or 28%) increasing to income tax levels of 20%, 40% or 45% for basic, higher and additional tax rate payers.
4. Explore a Venture Capital Trust
With the decreases in pension annual and lifetime allowances over the years, other arrangements which provide tax relief have increased in popularity. One such arrangement is the Venture Capital Trust (VCT) which allows you to make contributions of up to £200,000 each tax year. These are higher risk investments, which typically invest in smaller companies which can attract 30% income tax relief on the investment to be offset against your tax. They also pay dividends free of tax and are not subject to CGT. VCTs have to be held for at least five years, otherwise income tax relief will be withdrawn.
5... or an Enterprise Investment Scheme
Another arrangement that offers attractive reliefs is the Enterprise Investment Scheme (EIS). Again, these schemes invest in higher risk smaller companies and can attract up to 30% income tax relief to be offset against your tax bill. You can invest up to £1 million each tax year into such schemes, with a further £1 million allowed if invested in knowledge intensive companies. The investments can be used to defer capital gains arising on other assets. They also allow losses to be offset against other gains and should be free of Inheritance Tax after a holding period of two years. EISs have to be held for at least three years, otherwise income tax relief will be withdrawn and capital gains will be subject to tax.
5... Business owner? Make the most of Entrepreneurs’ Tax Relief
Under Business Asset Disposal Relief, financial gains from the sale of a trading business up to the value of £1 million are taxed at 10 % instead of at CGT rates. This applies to individuals who are registered employees or sole traders and have held shares for more than two years. The £1 million allowance is available per individual per lifetime for eligible transactions.
With CGT rates potentially rising, it could be beneficial to consider the timing of your private business sale in order to maximise use of this allowance, as lifetime gains greater than £1 million may be subject to increased CGT rates.
5... and maximise private pension contributions
If you run your own business you may be able to decide how much to pay into a private pension. The maximum contribution which can attract tax relief is £40,000. This allowance reduces if your adjusted annual income is more than £240,000 so you may choose to take a dividend that allows you to pay more into a pension pot.
However, a reminder that in some circumstances (detailed above), if your pension benefits have been accessed, the annual allowance will be reduced to £4,000.
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