1. Claim Tax back
Payments to personal pensions are made net of basic rate tax and so immediately attract tax relief at 20%. For example, an individual with a monthly direct debit of £400 will automatically be awarded £100 of tax back from HMRC meaning £500 is invested into the scheme.
However, for those paying higher rate tax at 40% or additional rate tax at 45%, there may be more tax to claim. Higher rate individuals may be able to claim a further £100 for every £400 paid while further rate taxpayers paying 45% income tax who may be owed £125. The table below illustrates three examples:
|Annual Gross Income||£40,000||£75,000||£175,000|
|Direct Debit to Personal Pension||£400||£400||£400|
|Immediate Basic Rate Tax Relief||£100||£100||£100|
|Higher Rate Tax Relief to claim||£0||£100||£100|
|Further Rate Tax Relief to claim||£0||£0||£25|
|Net Cost of Investment||£400||£300||£275|
Claiming the relief is simple, either via a self assessment tax return or by adjusting your tax code. For those who have not previously been claiming this additional relief, it is still possible to claim for previous tax years. A cheque in the post from HMRC is always a welcome sight!
2. Annual Pensions Allowance
The annual pensions allowance for the current tax year is £40,000 (16/17), although due to the recently introduced tapered annual allowance this figure varies depending on your total income for the tax year. Please see Pensions Annual Allowance for more detail.
The ‘carry forward’ rules mean it is now also possible for some individuals to carry forward unused pension annual allowances from three previous tax years to be used against this year’s gross income. This means it may be possible to invest a further £130,000 using unused past allowances.
Payment Input Periods (PIP)
Each scheme has its own ‘Payment Input Period’. With advice and careful planning, it is possible to close and reopen two periods around a tax year end, to facilitate an even larger pension contribution today. For somebody with strong earnings this year wanting to make a pension contribution to a SIPP for example, but having already used up the full annual allowance, smart flexing of the technical pension year can create the opportunity to contribute next years annual allowance to use against current year earnings and tax!
3. ISA – use it or lose it!
An individual savings allowance is just that – an allowance awarded to each of us that can be used to shelter our investments from the tax man. Each year all UK residents aged 18 or over (16 for cash ISA) are given a new allowance but if unused, it is lost.
PEPs were introduced in 1986 and were replaced by ISAs in 1999. Several individuals who have used their allowance each year since inception have managed to accumulate over £1m in this tax free environment, the so called ‘ISA millionaires’. This highlights the importance of religiously using up your allowance to benefit from years of tax free compounded returns, assuming sound investment choices are made of course.
The allowance for 2016/2017 is £15,240 – and it is up to you how much of this to allocate to investments and how much to hold in cash. The balance can be used to invest for the longer term in ‘real assets’ such as stocks and shares:
4. Simple Tax Planning
Married couples have the opportunity to transfer assets between one another, often with no immediate tax considerations which can provide important income and capital gains tax planning possibilities. This kind of planning needs a full tax year to play out to realise all tax savings so switching assets toward the end of a tax year would really only provide meaningful tax savings for the following tax year.
EXAMPLE: Where one spouse pays higher rate tax and the other zero or lower rate, it could be beneficial to transfer assets to the lower tax paying spouse. Bank account interest that is currently being taxed at 40% or even 45% can perhaps be reorganised so that in future the account is wholly owned by a non-tax paying spouse and taxed accordingly.
5. Capital Gains Tax (CGT)
Planning in this area is often overlooked in spite of many people owning assets which are appreciating in capital value and subject to this form of tax. The annual CGT exemption is £11,100 (2016/17) which cannot be carried forward so if not used, it will also be lost.
If no planning is implemented, gains tend to roll up until final disposal at which point a tax charge is levied on the total final gain without any possibility to use past exemptions. Basic rate tax payers are charged 18% on gains while higher rate tax payers are charged 20%. There is also an 8% surcharge added for the sale of residential property and carried interest.
EXAMPLE: An investor with a small portfolio of shares valued at £50,000 accumulating in value by 7% per annum might consider ‘crystallising the gains’ in a suitable manner on an annual basis to use part of the annual exemption. If this practice continued for say 5 years at which point the investor required the capital, now valued at just over £70,000, there would be no tax to pay on final disposal as all gains had been declared and assessed for tax annually.
The Bed-and-Breakfasting rules are designed to stop individuals avoiding tax by buying and selling the same asset straight away, by imposing a 30 day waiting period. There are however several variations of this concept used in tax planning that are allowed:
Crystallising the gains can be done without falling foul of the law in a number of ways:
3. ‘Bed-and-Something Similar’
An investment is sold then immediately bought back through an ISA. The investor ends up with the same asset, but the buying and selling triggers a calculation for capital gains tax.
One spouse sells an asset back to the market and then other spouse buys it immediately.
An individual could sell shares in one investment fund then buy new shares in a fund with a similar object and in the same sector.
An investment is sold, the cash proceeds paid into a SIPP then repurchased. Similar to Bed-and-ISA but the added advantage that the individual can then claim tax relief on the contribution into the pension
The information and guidance on this page is intended for illustrative purposes only. Anybody seeking to minimise their tax position should seek individual advice from an appropriately qualified professional who will be able assess their personal circumstances and the suitability of any planning. Please contact us today if you would like to explore your options further.