Make the most of this year's tax breaks
Cutting your tax bill by using available tax breaks is what every smart investor should be doing. Here are some simple ways to make the most of your annual tax allowances.
What you'll learn:Click to toggle accordion What you'll learn:
Tax-efficient ways to save and invest.
How much tax relief you’ll receive on your pension contributions.
How Inheritance Tax (IHT) works.
There are plenty of tax planning opportunities which can help investors legitimately minimise their tax bills.
Remember, however, that tax rules can change at any time in the future. Any favourable treatment currently available could later be altered or removed altogether. In any case, how valuable any tax breaks are to you depends on your individual circumstances, which can also change over time.
Tax should never be the only consideration when you're investing, or even the main one. Always keep in mind that you could lose money and this could outweigh any tax savings you might make.
Remember your personal allowance
Everyone has a certain amount of income they can earn each year without paying tax, known as their personal allowance. For the 2017-18 tax-year, this amount is £11,500.
Your personal allowance is in addition to the Personal Savings Allowance (PSA), introduced in April 2016, which means that most savers no longer have to pay income tax on the savings income (e.g. interest) they receive.
Your PSA depends on which income tax band you are in, with basic rate taxpayers entitled to a £1,000 allowance, while higher rate taxpayers receive a £500 allowance. Additional rate taxpayers are not eligible for a PSA.
Lots of married couples hold savings accounts in joint names, mainly because it's convenient. However, if one spouse is a higher rate or additional rate tax-payer and the other doesn't pay tax at all, it could be more tax-efficient to put the account solely in the non-taxpayer's name. This would give that spouse full ownership of the account, so you'll need to make sure you're both happy with the arrangement. One of the easiest ways to reduce your tax bill is to shelter the returns from your money in an Individual Savings Account (ISA). For the 2017-18 tax-year you can put up to £20,000 into an ISA.
Use up your ISA
One of the easiest ways to reduce your tax bill is to shelter the returns from your money in an Individual Savings Account (ISA). For the 2017-18 tax-year you can put up to £20,000 into an ISA.
You can choose to hold all of that in a cash ISA, or put it into a combination of investments, including funds, shares, gilts and bonds through an Investment ISA, or you can invest in peer-to-peer lending through an innovative finance ISA. Alternatively, you can split your allowance between a cash, investment, innovative finance and a lifetime ISA.1 However, with a lifetime ISA, you can only pay in up to £4,000 of your £20,000 allowance.
You won't be taxed on returns from savings or investments held in an ISA, nor will you have to pay Capital Gains Tax (CGT) on any of the profits you make. That's worth knowing because if your investments aren't held in a tax-efficient wrapper, you'd be taxed on profits above the annual CGT allowance, which in the 2017-18 tax-year is expected to be £11,300. The standard CGT rate is 10%, while the higher rate is 20%.
Even though the introduction of the PSA might appear to undermine the appeal of holding cash in an ISA, bear in mind that if interest rates start to rise and you earn more interest from deposit accounts, the less beneficial the PSA becomes. Returns paid out on cash ISA accounts, however, will remain entirely tax-free, although of course tax rules could change in future.
Dividends received in ISAs are also exempt from tax. If investments are held outside an ISA, the Dividend Allowance, introduced in April 2016, means that individuals receive their first £5,000 in dividends tax-free, but any dividends above this amount will be charged at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. However, it was announced in the March 2017 Budget that the Dividend Allowance will reduce to £2,000 from April 2018.
Remember that investments held both in and outside of an ISA, can fall in value as well as rise. You could get back less than you invest and, if you do, your losses can't be offset against other gains. Also bear in mind, tax rules and the rules on ISAs can change.
Topping up your pension
One of the most appealing aspects of pension saving is the boost your contributions receive from tax relief. But you can't touch the money in your pension until you reach the age of 55, rising to 57 by 2028.
You'll get tax relief at the basic rate of 20% on contributions made to personal and workplace pensions. So for every £80 you pay in, the taxman will top it up to £100. If you're a higher or additional rate taxpayer you can claim back up to an additional 20% or 25% through your self-assessment tax return.
But you’ll need to watch out for the annual pension allowance. This is the limit on the amount that can be contributed to your pension each year while still getting tax relief. For the 2017-18 tax-year, for most people, it's £40,000, or the value of your whole earnings - whichever is the lower. Lower allowances may apply if you have already started drawing a pension, or if you are a higher earner with income plus pension contributions that total above £150,000.
If you've used your full allowance in the current tax-year but not in recent years you may also, depending on your circumstances, be able to 'carry forward' any annual allowance which you haven't taken advantage of in the three previous tax years. There's also the Lifetime Allowance to consider. At the moment, if the value of all your pensions is more than £1m, anything over this limit will be taxed when you start using it.
There have been a number of reductions in the Lifetime Allowance and there are complex rules about claiming ‘protection' if you were close to, or you exceeded the new limit, having been below the previously higher limit.
You can find detailed information on your allowances, claiming 'protection' and how the 'carry forward' rule works on the Pensions Advisory Service website.
As with ISAs and other investments, remember that investments held in a pension can fall as well as rise. And always keep in mind that pensions and tax rules could change.
Cutting down on Inheritance Tax (IHT)
ISAs and pensions are the two big ways to shelter your money from tax, but there are other tools, at your disposal.
Your estate is valued when you pass away and chargeable to Inheritance Tax (IHT) at 40%, although the first £325,000 is exempt. Anything that goes to your spouse is also exempt.
Current tax rules enable you to give away up to £3,000 free of IHT each tax year. You can give away more than this amount if you want to but you must live for at least seven years from the date of the gift for it to be exempt from IHT.
Married couples and those in civil partnerships can also benefit from an additional family home allowance, which makes it easier to pass on the family home to direct descendants without incurring IHT charges. This was introduced on 6 April 2017 and will start at £100,000 and be phased in gradually, until the total IHT threshold reaches £500,000 per person in 2020-2021.
Tax rules can be complex, so it’s a good idea to get professional financial advice to help you work out the best ways you might be able to reduce your liability.
The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change in future. Their effects on you will depend on your individual circumstances.
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1 Barclays does not offer an innovative finance ISA or a lifetime ISA