While Rishi Sunak is under pressure to find new ways to fund higher public spending in the 2020 Budget, it could be savers that come under fire, as pension concessions for higher earners are a soft target. Now is the time to make use of your tax-free allowances – February revealed that the Treasury is considering plans to halve the rate of pensions tax relief for higher earners – from 40% to 20% – in a move that could raise as much as £10 billion a year.
Whether you are among the estimated one in seven taxpayers affected by this or not, the end of the financial year is fast approaching, so now is the time to use your allowances while you can. After all, we don’t know how much longer they’ll be around.
Don’t neglect your pension
The tax relief system for pensions is complicated, and all depends on the amount of income tax you pay; when you pay money into a pension, the Treasury pays back the Income Tax you’ve already paid on that money. So, if you are a basic-rate taxpayer, you’ll get 20p back for every 80p you pay in. Higher-rate taxpayers (who earn above £50,000) get back 40p for every 60p paid in, and top-rate taxpayers (who earn above £150,000) receive 45p for every 55p. Don’t be caught out, however – basic-rate taxpayers automatically receive this relief, but those on the higher and top-rate tiers who contribute to a personal pension often need to claim the relief back themselves.
This giveaway is hugely expensive. The loss of Income Tax and employer’s National Insurance as a result of the various reliefs adds up to £40 billion a year.1
There is also a limit to how much you can contribute to your pension each year – it is capped at £40,000 for everyone except top-rate taxpayers, whose limit will taper until it reaches £10,000 on incomes of £210,000 or more. There is also a limit of £1,055,000 that you’re entitled to build up over your lifetime, and those who exceed this limit could face up to 55% in penalty charges.
Charles Calkin, a Financial Planner at James Hambro & Partners, told The Times:
“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. 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%.”2
And it’s not too late to maximise on previous years either – you’re able to carry forward any unused allowance from the past three years into this year, which means you could invest up to four years’ contributions (£160,000) in your pension. This will effectively save you at least £64,000 in tax, as long as your contributions are from higher-rate earnings. Of course, if your total income, including investment and rental income, goes above £150,000 you will then be hit by the tapered allowance.
Don’t forget you can also make pension scheme contributions of up to £3,600 for spouses, civil partners or children if they have no earnings and are on the basic rate of relief. That means if you contribute £2,880, HMRC would then top it up to £3,600.
Be wise with your dividends
The first £2,000 of dividends are tax-free for all investors, but anything above that is subject to income tax – 7.5% at the basic rate, 32.5% at the higher rate and 38.1% at the top rate of tax. It is therefore advisable for investors to put as much as possible into an Individual Savings Account (ISA). You’re allowed up to £20,000 a year to add into ISAs and it won’t be subject to 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% 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.”3
Utilise savings allowance
For basic-rate taxpayers, the first £1,000 of annual savings interest is tax free; higher-rate taxpayers receive a £500 allowance, while top-rate taxpayers get nothing. If your savings income is above the allowance, you can shelter some in a cash ISA (as long as you have not gone over your ISA allowance), and your interest payments will then be free from tax.
Minimise Inheritance Tax
More and more people are becoming subject to Inheritance Tax (IHT) due to rising house prices and stock markets. This means you should think about minimising the bill your heirs may have to pay, and gifts are one of the best ways to do it.
You can give away unlimited amounts of wealth to anyone you want free of IHT, provided you live for seven years after giving it. You can also give up to £3,000 a year in any way you choose, plus make as many gifts as you like of up to £250 to different people, all free of IHT.
Make use of your Capital Gains Tax allowance
Aside from assets in an ISA or pension, Capital Gains Tax (CGT) is charged on any that are cashed in that have risen in value. Everyone gets an allowance of up to £12,000 of gains, which can be cashed in yearly without tax. After that, basic-rate taxpayers are charged 10% and higher-rate taxpayers 20% – gains accrued on residential property (other than a primary residence) also carries an extra 8% tax on both basic and higher rates.
If you have a spouse or civil partner, you can effectively double your CGT allowance by giving assets to them that they are able sell – this is particularly useful if your partner pays a lower tax rate.
Invest in VCTs and EISs
Venture capital trusts (VCTs) allow you to invest up to £200,000 a year with tax relief of 30% on the sum, and, if you keep it invested for at least five years, the money will build free of income tax or CGT. 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.
Enterprise investment schemes (EISs) are when you invest directly into a small and growing business, thereby holding a direct stake in the company. With these, you’re able to invest up to £1 million a year with tax relief of 30%, as long as you hold the investment for three years. While there is no CGT on gains, dividend income is still taxed. After two years, the investment is then eligible to be passed on without inheritance tax.
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1 gov.uk, January 2020
2, 3 The Times, ‘How to make the most of your tax allowances’, 25 February 2020