By Neil MacLeod, Technical Manager at Prudential UK
The tax year in the UK runs from 6 April until 5 of April the following year. While most individuals’ income for a tax year is deducted at source through their employment, the self-employed and those with other untaxed income and gains need to complete a self-assessment tax return.
If you need to complete a tax return and haven’t done it already, the deadline for completion online for the 2019/20 tax year was midnight on 31 of January 2021. Incidentally this is also the same deadline for paying any income tax or capital gains tax due. Failure to submit your tax return on time results in an immediate £100 penalty from HMRC as well as potentially larger penalties for late payment of the tax due.
There’s little in the way of tax planning that can now be done for 2019/20 but there’s still time to put your house in order before 5 of April 2021 for the current tax year. Here are some of the main allowances and exemptions that you should be looking to make use of before 5 April.
Income tax is payable on your taxable income received during the tax year. This comes in many forms such as earned income from employment, interest from savings or dividends from investments.
However, most individuals are entitled to a “personal allowance” each tax year, currently £12,500, to offset against their income before tax is calculated. Income within the personal allowance is tax-free but you can’t carry forward any unused amount to a future tax year. So if you haven’t used your full personal allowance this tax year it might be worth considering increasing your income before the end of the tax year. If you have a “Drawdown” pension pot for example when your pension remains invested and you can draw from it at any time. The amount withdrawn is taxable pension income but you can take income up to the personal allowance to get money out of your pension tax free. And if you have available personal allowance and hold an offshore insurance bond then now could be the time to crystallise some of the profit made. Gains made on offshore bonds are classed as savings income and any savings income within the personal allowance is also tax free.
Alternatively, if you have a spouse or civil partner who is a basic rate taxpayer you may be able to transfer some of your unused allowance under the “marriage allowance” rules.
If you are married or in a civil partnership and your taxable income is below £12,500 then you can potentially transfer up to 10% of your unused personal allowance to your partner. The recipient must not have income which is taxable at the higher or additional rate of tax before the transfer but making use of the marriage allowance can potentially give a tax saving of up to £250 for the recipient. You can also backdate your claim to include any tax year since the 5 April 2016 so it’s well worth taking advantage of this where possible.
At the other end of the scale, if you are a high earner your personal allowance may be reduced or lost altogether. Where someone has “adjusted net income” exceeding £100,000 their personal allowance is reduced by £1 for every £2 of income over this threshold. This means where adjusted net income is £125,000 or more you will have no personal allowance for the tax year concerned.
“Adjusted net income” is broadly your taxable income less the gross amount of any gift aid or pension contributions. So if you do find yourself in this situation it is sometimes a good idea to make a pension contribution to reduce your adjusted net income below £100,000. Not only does this get your personal allowance back but you receive tax relief on the contribution.
Pensions are a very tax efficient way of saving for retirement. Contributions made to pensions receive tax relief at the member’s highest marginal rate and the underlying investments are not subject to income tax or CGT so grow free of tax within the pension.
Most people pay in a small amount of their employment income to a pension but you can actually contribute up to 100% of your earnings into a pension and benefit from tax relief. You can’t use earnings from one tax year to support a contribution in later tax years. So if you have sufficient earnings in the current tax year, spare capital and don’t need to access the money until retirement then maximising contributions before 5 April is definitely worth further investigation.
If you are thinking about increasing contributions to a pension, you should consult a financial adviser as there are other considerations such as “Annual Allowance” which need to looked at to make sure you don’t incur unnecessary tax charges for paying in too much.
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Not all income is taxable though. While interest and dividends from your investments will normally be taxable, if you invest within an ISA wrapper any income generated is tax free.
Any growth in the value of your ISA (capital gains) are also exempt which makes ISAs a valuable allowance for most people. There are limits on how much you can invest in an ISA each tax year depending on whether you are an adult or a child under 18 so you need to be aware of these to avoid over subscribing.
Adults have an ISA allowance for contributions in the current tax year of £20,000 which can be invested in cash or stocks and shares.
Children under the age of 18 can hold a junior ISA (also known as a “JISA”) and the contribution limit on these for the current tax year is £9,000. Only parents or a guardian with parental responsibility can open a child’s JISA but anyone can pay money in as long you stay within the limits. This provides a useful home for gifts from grandparents where they would like the money invested although it’s important to understand the child can access the funds when they turn 18.
Capital gains made on sale of various investments such as shares in Open Ended Investment Companies (OEICs), or on disposal of a property which is not your main residence, are normally subject to Capital Gains Tax (CGT). In a similar way to the personal allowance for income tax, there is an “annual exempt amount” each tax year for capital gains. The annual exempt amount for the current tax year is £12,300 and any gains within this are free from tax. Gains in excess of the annual exempt amount are added on top of your taxable income and liable for CGT. Where gains fall within the basic rate band they are taxed at 10% (or 18% if the gain relates to residential property). Gains in the higher or additional rate bands are taxed at the higher rates of 20% (28% for gains arising from residential property). Importantly you cannot carry forward any unused annual exempt amount from a previous tax year so it’s a case of use it before the end of the tax year or it will be lost. Many people take advantage of the annual exempt amount each year to move some of their taxable OEIC portfolio into a more tax efficient investment such as an ISA or pension. It’s common nowadays for the same underlying investment funds to be available within an OEIC, ISA or pension, so you can still invest in the same investment, just on a more tax efficient basis. This strategy is often referred to as “Bed and ISA” or “Bed and Pension” depending on where the money is being moved to.
As well as managing the taxes that apply on an annual basis there are also some planning opportunities relating to Inheritance Tax, which applies to gifts made either during lifetime or on death.
The majority of IHT planning is not tax year specific as it tends to take the form of making gifts and waiting seven years for these to be excluded from your taxable estate. That said there are a couple of exemptions that are linked to the tax year. While these exemptions are not huge, they can definitely help “chip away” at your IHT liability over time.
While most gifts incur a “seven- year clock” everyone is allowed to make exempt gifts of £3,000 each tax year. This “annual exemption” can be used against multiple smaller gifts but can also be offset against a larger gift, for example a gift into a trust. As well as the current tax year’s exemption you can also carry forward any unused exemption from the previous tax year.
The annual exemption is a good way of making gifts to grandchildren either into their JISAs or, if you don’t want them to have access until much later in life, into a pension. Although young children rarely have any earnings to support large pension contributions it’s still possible to make a gross tax relievable contribution of £3,600 each year into a pension on their behalf. If you pay this into a personal pension the net payment is £2,880 so it falls under the £3,000 IHT exemption. The pension provider then claims the tax relief from HMRC and adds to this to the child’s pot.
You don’t need to claim the annual exemption when the gift is made but it may need to be claimed on death by your executors if you die within seven years. It’s therefore important that if you do make any gifts to keep a record to ensure the exemption can be claimed.
Break out box
Find out more about tax and cash gifts.
Small gifts exemption
And finally, the small gifts exemption allows an individual to make gifts of up to £250 to another individual and for these to be exempt from IHT. The gifts can be below £250 but if the total gifts you make to a person throughout the tax year exceeds £250 then the exemption doesn’t apply to any of them (so you can’t combine it with the annual exemption).
Although £250 may seem insignificant the exemption can be used to an unlimited number of people so if you have a large family or lots of friends you would like to benefit from your estate the gifts do add up.
There are numerous tax planning opportunities available each tax year which can save you money. In most cases if you don’t make use of these in the tax year concerned then you can’t use them in future years so it’s important to ensure you take the time each year to review your financial position. That said, there are some common pitfalls which need to be avoided so it is definitely worthwhile employing the services of a professional financial adviser to guide you through the process.
Information is correct as of the date of publication (shown at the top of this article). Any products featured may be withdrawn by their provider or changed at any time.