Tax relief on savings us once more under threat. So use your allowances while you can.
Savers are in the new chancellor’s firing line as budget day approaches. Rishi Sunak is under pressure to lay out ways to fund higher public spending in his March 11 statement, and pension concessions for higher earners are a soft target.
This week it emerged that the Treasury was considering plans to cut the rate of pensions tax relief for higher earners from 40 per cent to 20 per cent. The move could raise £10 billion a year as 3.85 million people — equivalent to one in seven taxpayers — pay the higher rate of income tax and are entitled to tax relief on pension contributions.
Whether you are among them or not, with the end of the financial year six weeks away you still have a little time to make use of your tax-free allowances. Act quickly — you don’t know how much longer they’ll be around.
Pay more into your pension
Pension tax relief costs the government close to £40 billion a year, so it is likely to be a target for a cash grab by the chancellor. It makes sense to maximise your contributions now.
The system is complex. When you save into a pension the Treasury gives you back the income tax you have already paid on that money. So if you are a basic-rate taxpayer, when you pay 80p of taxed income into a pension you get back the 20p you paid in tax. Higher-rate taxpayers (who earn more than £50,000) get back 40p for every 60p they pay in, and top-rate taxpayers (who earn more than £150,000) get back 45p income tax for every 55p they pay in.
Basic-rate taxpayers automatically receive the relief, but higher and top-rate taxpayers who contribute to a personal pension often have to claim back the 20 per cent or 25 per cent, respectively. Many people who do not fill in a self-assessment form forget to do this and can lose thousands of pounds a year. How much you can contribute to your pension each year is capped at £40,000, except for top-rate taxpayers, whose contribution limit tapers until it reaches £10,000 on incomes of £210,000 or more.
Over your lifetime you are entitled to build a pension pot of £1,055,000. If you exceed the limit you could face penalty charges of up to 55 per cent.
“For high earners who are not close to breaching the £1,055,000 lifetime allowance there is a lot to be said for pumping as much as you can into your pension because these benefits look under threat,” says Charles Calkin, a financial planner at James Hambro & Partners. “Those earning more than £100,000 should particularly consider this. For every £2 you earn over £100,000 you lose £1 in personal allowance. The effect of this is that your marginal rate of tax between £100,000 and £125,000 is 60 per cent.”
If you have not maximised your pension contributions in the past three years you can carry forward the unused allowance into this year. That means you could invest £160,000 (three years’ contributions, plus this year’s one) in your pension. This will save you at least £64,000 in tax, assuming your contributions are from higher-rate earnings.
A caveat is that if your total income, including investment and rental income, takes you over the £150,000 threshold, you will be hit by the tapered allowance. You can also make contributions of £3,600 into a pension scheme for a spouse, civil partner or child if they have no earnings and are on the basic rate of relief. So if you contribute £2,880, HMRC will top it up to £3,600.
Use your dividends wisely
All investors receive the first £2,000 of dividends tax-free. Anything above that is subject to income tax on dividends at 7.5 per cent if you are a basic-rate taxpayer, 32.5 per cent for higher-rate payers and 38.1 per cent for those on the top rate of tax.
To avoid getting hit, investors should shift as much as possible of their dividend-bearing investment into an Individual Savings Account (Isa). You can put £20,000 a year into an Isa and the money will roll up free of income tax or capital gains tax.
Laura Suter of AJ Bell, a wealth- management company, says: “By holding an investment pot of £100,000 that is yielding 4 per cent in, rather than out, of an Isa an investor will save £150 a year in tax if they are a basic-rate taxpayer, £650 a year if a higher-rate taxpayer and £762 a year if a top-rate taxpayer.”
Wrap up your savings allowance
Basic-rate taxpayers get the first £1,000 of annual savings interest tax-free. Higher-rate taxpayers receive a £500 allowance, but top-rate taxpayers get nothing. If you have savings income above the allowance, shelter some in a cash Isa, provided that you have not used up your Isa allowance. Your interest payments will not be subject to tax.
Reduce your inheritance tax bill
Rising house prices and stock markets mean that more people have wealth substantial enough to trigger inheritance tax (IHT) on their estate when they die. To minimise the bill your heirs may have to pay, consider gifts. You can give away unlimited amounts of wealth to whomever you want, and if you live for seven years after giving it there will be no IHT to pay. You can also give away up to £3,000 a year, in any way you want, and make as many gifts as you want of up to £250 to different people free of IHT.
Use your annual capital gains tax allowance
Unless assets are in an Isa or pension, capital gains tax (CGT) is charged on any you cash in that have risen in value. We each have a CGT allowance of £12,000 of gains that we can cash in yearly free of tax. Higher-rate taxpayers pay 20 per cent on gains over the allowance. For basic-rate taxpayers it is 10 per cent. Gains on residential property other than a primary residence carry an extra 8 per cent tax on the basic and higher rates.
If you are a higher-rate taxpayer and sell £50,000 of shares that you bought a decade ago for £10,000, the gain is £40,000. Your £12,000 CGT allowance means you pay tax on a gain of £28,000 at 20 per cent. You can give assets to a spouse or civil partner without triggering CGT. They can sell some, and you have effectively doubled your CGT allowance. This is most useful if your partner pays tax at a lower rate.
Invest in VCTs and EISs
People are turning to venture capital trusts (VCTs) and enterprise investment schemes (EISs) to shelter money. With VCTs you can invest up to £200,000 a year and receive tax relief of 30 per cent on the sum. The money builds, free of income tax or CGT, if you keep it invested for at least five years. It goes into a portfolio of “qualifying companies” on the alternative investment market that are less than seven years old and have less than £15 million of gross assets.
With an EIS you invest directly into a small and growing business, so that you hold a direct stake in the company. You can invest up to £1 million a year and receive tax relief of 30 per cent if you hold the investment for three years. There is no CGT payable on gains, but dividend income will be taxed. After two years the investment is eligible to be passed on free of inheritance tax.
Source: Mark Atherton of the Times February 2020