As the new tax year looms, it is not too late to protect your wealth from the taxman’s long arm. Sam Barrett outlines 10 ways to cut your tax bill.
With the new tax year starting on 6 April, there’s still time to ensure your finances are as tax-efficient as possible. And while some allowances can be carried forwarded, with many it really is a case of use it or lose it.
1) Use your Isa allowance
The introduction of the personal savings allowance, which allows you to earn up to £1,000 of interest tax-free (£500 for higher-rate taxpayers), and the dividend allowance of £2,000 in 2018/19 means many people no longer pay tax on their savings and investments.
While this means Isas have lost some of their tax-free appeal, Iain Tait, partner and head of the private investment office at London & Capital, says they should still be on everyone’s tax planning agenda. “With a £20,000 allowance for adults and £4,260 for children, a family of four could put nearly £50,000 into Isas in this tax year,” he explains. “Even if you’re not currently paying tax on your savings and investments, Isas are a good way to shelter this money from future income and capital gains tax.”
2) Pay into your pension
Pensions deserve attention at tax year end for two reasons. As well as enabling you to benefit from tax relief on contributions, they can be a great way to reduce the amount of tax you pay overall.
This is particularly the case for anyone earning more than £100,000, as Lee Clark, head of office at Brewin Dolphin, explains: “If your earnings exceed £100,000, your tax-free personal allowance will be reduced by £1 for every £2 you earn above that amount. By the time you earn £123,700, it will have gone completely. Making a pension contribution can reduce your taxable income and restore your personal allowance.”
This strategy can also help with child benefit. Under the high-income child benefit charge rule, benefit is effectively withdrawn at the rate of 1% for every £100 of income the higher-earning parent receives over £50,000. At the point their earnings hit £60,000, any entitlement will have disappeared. Clark says: “If you’re earning £52,000 and you pay £2,000 into your pension, you’ll restore your full entitlement to child benefit. This can be a significant amount, especially for larger families.”
For instance, a family with three children would receive £48.10 a week in child benefit, but this is reduced by 20% – £9.62 a week – if the higher earner’s income is £52,000. For this family, making a £2,000 pension contribution could be worth just over £500 a year in child benefit.
3) Use other people’s pensions
As well as topping up your own pension, it may also be worth paying attention to your partner’s retirement savings. Even if they don’t have any income, you can still pay in £2,880 in this tax year and see tax relief top this up to £3,600.
As well as taking advantage of tax relief, this strategy can bring benefits further down the line.
Jeannie Boyle, director and chartered financial planner at EQ Investors, says: “It can be tempting to focus on the main earner, but by building up both pensions, you can potentially take advantage of two income tax allowances in retirement, rather than just one.”
For a couple in retirement, using two personal allowances instead of one could save as much as £2,370 in tax a year, at 2018/19 rates.
4) Crystallise a gain…or a loss
The joys of making a profit when you sell an ‘unwrapped’ investment can be diminished when you’re hit with a capital gains tax (CGT) bill. Once you’ve used up your annual allowance (£11,700 in 2018/19), CGT is charged at 10%, or 20% on any gain that falls into the higher-rate tax bracket.
To avoid being hit with this tax, Julia Rosenbloom, partner and head of private client tax services at Smith & Williamson, recommends planning ahead. “Sell sufficient investments each year to use up the annual allowance and crystallise the gain,” she says. “You can reinvest the proceeds, but be careful you don’t go back into the same investment within 30 days. This won’t qualify as a new investment, so you’ll retain the gain.”
It’s prudent to be mindful of any losses you might have made, as these can be off set against gains. Clark says: “You need to register a loss through your tax return, but you have up to four years from the end of the tax year in which you make the loss to make your claim. Holding over losses can be especially beneficial if you’re planning to sell an asset that would generate a significant gain or be subject to a higher rate of CGT, as is the case with property, which is taxed at 18% and 28%.”
5) Time your disposal
If you are fortunate enough to be sitting on a large gain and don’t have time to reduce it by using a series of annual CGT allowances, selling at the right time could help you minimise your tax bill.
Straddling two tax years and splitting a gain into two sales allows you to benefit from two CGT allowances. With the allowance rising to £12,000 in 2019/20, you could realise a gain of £23,700 by this tax year end without paying CGT.
While this works well with investments, Rosenbloom says it takes a bit more effort with property. “You would need to split the transaction, which may come down to the buyer’s attitude to this,” she says. “Also check you’re not incurring more costs in legal fees than you’re saving in tax.”
Timing can also come into the equation if you have a variable income, for instance from income drawdown in retirement. As an example, say you had an artwork that had risen in value from £5,000 to £25,000. If your income was £50,000, you’d pay higher-rate CGT on the £8,300 gain (£20,000 minus the £11,700 allowance), amounting to £1,660. Decide instead to live on the proceeds of the sale so that your only taxable income is the basic state pension (£6,550 a year) and the gain will be subject to CGT at 10%, giving you a tax bill of £830.
6) Use your other half’s allowances
If you’re married or in a civil partnership, you can also take advantage of your partner’s tax allowances to give you a little more flexibility around your tax planning. “Think about who owns what,” says Boyle. “If one of you has a lower tax rate, put taxable savings and investments in their name.”
This ensures their personal savings and dividend allowances are used, and if there’s any further tax to pay, it’s at a lower rate than it would be if it were in your name. For example, if you earn £50,000 a year and you receive a £20,000 dividend, you would be liable to tax at 32.5% on the £18,000 above the £2,000 dividend allowance. This equates to a £5,850 bill. In comparison, if your spouse earns £15,000, this dividend would only be taxed at 7.5%, resulting in a tax bill of £1,350.
As well as taking advantage of their lower income tax band, you can use their CGT allowance. Providing items are held jointly, which may require some paperwork, you can effectively double your CGT allowance from £11,700 to £23,400.
7) Give to charity
Your primary motivation for giving to charity may be to support a cause close to your heart, but such giving can also benefit you financially. “If you sign up to Gift Aid, a charity can reclaim basic-rate tax on donations, automatically increasing their value by 25%,” explains Boyle. “You get additional benefit if you’re a higher-rate taxpayer, as you can claim the additional tax back through your tax return.”
For example, if you’re a higher-rate taxpayer and you donate £500 to charity, the charity will be able to claim £125 back in Gift Aid, taking your donation up to £625. You will also be able to claim back £125 from the taxman, which you can keep yourself or pass on to the charity.
There’s a further benefit too. “A gift to charity can reduce your taxable earnings in the same way that a pension contribution does,” says Boyle. “This can help some earners drop below the £100,000 income level to retain the personal allowance, or below £50,000 to keep child benefit entitlement.”
8) Take more risk
If you’re comfortable taking more risk with your money, investments in venture capital trusts (VCTs) and enterprise investment schemes (EISs) come laden with tax benefits that you can take advantage of before the end of the tax year.
Both VCTs and EISs offer income tax relief at 30%. “If you invest £10,000, you’ll make a saving of £3,000 on your income tax bill,” explains Alex Davies, chief executive at Wealth Club. “On top of that, dividends are paid tax-free on a VCT. If you invest in an EIS, providing you hold it for at least two years and on death, it will not be subject to inheritance tax.”
EISs also offer loss relief, providing some off set if performance is poor. As an example, if a higher-rate taxpayer invested £10,000 in an EIS and it was only worth £5,000 when they sold out, they would be able to deduct the £2,000 loss (£5,000 minus the £3,000 income tax relief they received when they invested) from their taxable income, reducing their income tax liability by £800. Taking both the income tax and loss relief into account, this would shrink the £5,000 loss to just £1,200.
In spite of all the tax breaks, these investments aren’t for the fainthearted. Davies says: “You’re investing in small companies, so performance tends to be volatile. As a result, we find they appeal to wealthier individuals who have already used up their pension and Isa allowances.”
9) Make use of your annual IHT exemption
While most inheritance tax planning is governed by the seven years it takes for assets to leave your estate, the annual exemption is linked to the tax year. This lets you give away £3,000 worth of gifts in each tax year, which will immediately be outside your estate for inheritance tax purposes.
Again, it’s a case of use it or lose it, although there is some leeway. Boyle explains: “You can carry forward any unused exemption into the next year, but only for one year. The benefit might not seem much, but carrying forward is easy and the gain can add up over the years.”
Importantly, with inheritance tax at 40% of everything over the nil rate band (£325,000), the saving can be significant. Assuming these gifts skim £3,000 off your taxable estate, they would save you – or more accurately your beneficiaries – £1,200 in inheritance tax.
10) Postpone a separation
Tax might not be at the forefront of your mind if you’re looking to end a marriage or civil partnership, but postponing a separation until a new tax year begins could save you money. “Married couples and civil partners can move assets between them without incurring a CGT liability. But if they separate, that tax break only lasts until the end of that tax year,” explains Rosenbloom.
This is a particularly important consideration where a second property is involved. As an example, say a couple separate and decide that one of them should have the house in London while the other gets the holiday cottage. Transferring ownership of the cottage isn’t an issue if it’s done in the tax year of separation, but doing it in the next tax year could entail a big bill.
Assuming the property has increased in value from £500,000 to £800,000 since purchase, transferring half of this to the former spouse would mean crystallising a gain of £150,000. After deducting the £11,700 allowance, this would mean a CGT bill of £38,724 (28% of £138,300) for a higher-rate taxpayer.
Regional tax variations
Over the past decade, tax devolution has given the Scottish and Welsh governments the power to set their own taxes, resulting in a number of tax differences between England and the rest of the UK.
In Scotland, this has resulted in a five-band income tax system starting at 19% for income up to £2,000 and rising to 46% (the top rate) for income over £150,000. “These bands only apply to non-savings income,” says Tony Mudd, divisional director, development and technical consultancy, at St James’s Place. “This means a Scottish taxpayer can be paying up to eight different taxes on different sources of income. If an individual lives full time in Scotland, they will be a taxpayer there, but if they split their time between Scotland and other parts of the UK, they may find it worth looking closely at the definition of a Scottish taxpayer.”
The Welsh government has had powers to set land transaction tax and landfill disposal tax rates since 1 April 2018, and will have partial income tax rate powers from the beginning of the 2019/20 tax year. The rates have yet to be decided, and may remain the same, but Mudd says it will be sensible to check residence status if these diverge from those set by the UK government.