(tax) Planning ahead

While it’s a good idea to make sure you’ve made the most of your allowances as tax year end approaches, it’s just as important to plan ahead to get the best outcomes for your money and avoid a last-minute panic.

At this time of year, there are always pre-tax year end ‘use it or lose it’ articles in the newspapers encouraging you to make the most of your tax allowances before the end of the tax year. While of course, you should always make the most of the tax allowances available, working with your adviser at the start of the tax year to plan for the year ahead is often more beneficial for your long-term finances – and your stress levels.

When is the UK tax year?

Our tax year runs from 6 April to 5 April, which is something of a global anomaly. In most countries, they run with the calendar year or 1 July to 30 June. The Government is considering moving the tax year end to either 31 March or 31 December1, but there are costs involved with doing that so for now, it’s staying as is.

What allowances do I have?

Your tax allowances are the tax breaks set by the Government on investment and pension products to encourage people to put money away for their future. Many have been frozen until the 2025/26 tax year, but in the recent Spring Statement, the Chancellor acknowledged the complexity of the UK tax system and pledged to reform some reliefs and allowances ahead of 2024. So limits and rules may change in the future, but here’s are the main ones as they stand.

Individual Savings Accounts (ISA)

ISAs are an important tool when it comes to tax-free saving. Adults can contribute up to £20,000 per tax year across one or more of four types of ISA, with all gains and income generated exempt from Capital Gains Tax and Income Tax.

Stocks & Shares and Cash ISAs are the most well-known adult ISAs, but there is also the Innovative Finance ISA (IFISA) and Lifetime ISA (LISA). With an IFISA you lend money via an online peer-to-peer platform and earn tax-free interest on the loan. These offer higher interest rates than cash accounts but are high risk as you could lose money if borrowers do not pay the loan back.

LISAs are only available for 18 and 39-year-olds, but once open you can carry on paying into it until you’re 50. The maximum annual limit is £4,000 (of the £20,000 overall ISA allowance) to which the government adds a 25% bonus per year. However, the money must be used for retirement, in which case it can’t be withdrawn until you turn 60, or to buy your first home. If you withdraw early or for anything else, you’ll be charged 25% of the amount you withdraw.

For under 18s, there is the Junior ISA. These must be opened by the child’s legal guardian, but once open, anyone can pay into the account, up to the annual limit of £9,000.

Personal savings allowance (PSA)

It’s important to hold some cash to cover unexpected expenses or if you plan to spend it within three to five years. However, Cash ISA interest rates are currently low and often beaten by ordinary savings accounts2. Basic-rate taxpayers can use their PSA to earn £1,000 per year in savings interest tax-free, while higher rate taxpayers can earn £500. So unless you need to keep a lot of money in cash, you could earn a higher rate of tax-free interest in a regular savings account and leave your ISA allowance for another type of ISA.

Capital gains tax (CGT)

CGT applies when you make a profit selling a chargeable asset, which includes investments held outside an ISA, personal possessions worth more than £6,000 (apart from your car), and property (apart from your main home). You only pay tax on profits above the current CGT allowance of £12,300 and what you pay depends on the size of the gain and your income tax band. It can be as much as 28%, so it’s well worth factoring in the allowance when planning to sell assets.

Pensions

Tax relief on contributions gives pensions an important advantage over other long-term investments. You receive tax relief on pensions contributions at your highest marginal tax rate. Currently, the Government automatically boosts your pot by 20% and higher rate taxpayers can claim additional tax relief from HMRC. In the Spring Statement, the Chancellor announced a cut in basic income tax from 20% to 19% in April 2024, which will also reduce the Government’s automatic top up to 19% from that point too. That means if your contribution was £100 per month, with basic rate tax relief it would be £125, but after April 2024, it will be £123.50. Although £1.50 a month doesn’t sound like much, it can make a surprising difference to your pension pot over the long-term. If you can afford it, basic rate tax payers may want to consider upping your contributions over the next two years to make the most of the current rate before the reduction.

Currently, most taxpayers can contribute up to 100% of their earnings into a pension, up to a maximum of £40,000 per year including any employer contribution and government tax relief. However, for very high earners, the annual allowance is reduced on a sliding scale in line with earnings, down to £4,000. Plus there is the lifetime allowance to consider, which is currently £1,073,100 to cover the combined value of all the pensions you hold, excluding your State Pension.

Staying within these allowances is important because you’ll face a hefty tax charge if you exceed them. Your financial adviser can help you navigate the rules and discuss your options if you are running close to the limits.

Pensions can also be a tax-efficient way of saving for children as anyone can get basic rate tax relief on pension contributions up to £3,600, regardless of earnings. However, remember that the money will be locked away until the child reaches the minimum age set by the government, which is currently 55, but will rise to 57 from 2028.

Inheritance tax (IHT)

According to government figures, the IHT charge per estate has increased in recent years3. At 40% on estates valued over £325,000, IHT can make a serious dent in the amount you leave your loved ones.

You can reduce your IHT bill by making gifts during your lifetime, rather than waiting to leave an inheritance. Gifts of up to £250 per person per year are exempt and if you want to give more, you have a £3,000 annual ‘gift allowance’ which can be given to one person or split between several.

Although £3,000 might not sound like much if you have a large estate, gifting it now rather than after death could save £1,200 in IHT. And if you make use of the allowance every year for ten years, you’d be able to give away £12,000 more than if you bequeathed the same amount in your will.

Next steps

Using Government approved tax-breaks to reduce the amount of tax you pay is an important way to maximise your future finances. However, the rules can be complex and vary depending on your personal circumstances. We’re here to help make sure you are making the most of your tax allowances, preserving your wealth for yourself and your loved ones without falling foul of the taxman.

1https://www.gov.uk/government/publications/exploring-a-change-to-the-uk-tax-year-end-date

2https://moneyfacts.co.uk/savings-accounts/ accessed 28/02/2022

3https://www.gov.uk/government/statistics/inheritance-tax-statistics-commentary/inheritance-tax-statistics-commentary