The rate of inflation is forecast to remain high for the foreseeable future. More of us who are working will be dragged into higher tax brackets as earnings increase and brackets remain static, while those who are retired may draw more from their pension to cover the cost of living, changing our eligibility for certain reliefs and exemptions.
Paul Poulter joins us from Wren Sterling’s Oxford office, our new hub thanks to the acquisition of Critchleys Financial Planning LLP earlier in 2022.
This article will go through some of the allowances and exemptions that you will definitely know about, and some you might not to maximise the effectiveness of your financial planning.
It’s important we make the most of our money. This is where the UK’s system of allowances and exemptions come in. They’re universal. They’re designed to help us. And they’re put in place for us to legally benefit from. But they can add complexity, which is why some people are missing out on the reliefs they’re entitled to.
Warning signs for complexity
When I’m talking to new clients or completing a review, I’m looking for trigger points that suggest whether their circumstance could require greater scrutiny, such as;
- Changes to your income tax band
- Irregular income from bonuses, dividends, investments, or inheritance
- If you have children, or a recent change in your marital status
You can invest up to £20,000 a year into your ISAs. Any gains will be free from capital gains tax (CGT) or income tax – so it’s a great place to start. If you have children, you can also consider Junior ISAs, and can invest £9,000 a year on their behalf (and grandparents can help too). For young adults (between 18-40) the Lifetime ISA with an annual limit of £4,000 is highly efficient, with the Government adding 25% to each contribution when used for a first-time property purchase or for retirement. Like many of the allowances, reliefs and exemptions in this article, if you don’t use them, you lose them.
Utilise at the start of the tax year and avoid the rush
When speaking to new clients, it’s not unusual to find that they haven’t actually utilised that year’s ISA allowance – even as the tax year end approaches. As an adviser, I would encourage you to use this at the start of the year. Waiting to use these allowances means that you’re not benefitting from the possible growth during that year. So, if you’re able to, it’s always a good idea to use them as early as possible.
Put money aside for your future
Pensions are simply a tax-efficient vehicle designed to help you invest for your retirement. Each year, you can save up to £40,000 into a defined contribution pension tax-free. If you have already put this amount into your pension this year, but would like to put more aside for your retirement you can benefit from carry forward rules. You can use any unused annual allowance from the last three years.
Naturally, this can be complex work with penalties for getting it wrong, so please always speak to your adviser first!
Gifting to charity
There’s a lot of information on charitable gifting in your Will – but did you know that gifts to charity are exempt from income tax and capital gains tax? So, you can benefit society, and help yourself out if you’re teetering on the edge of a higher tax bracket.
Start your IHT planning
At 75, you can still make payments into your Defined Contribution pension, but will no longer gain tax relief on your contributions. However, as pensions can be passed on outside of your estate (you’ll need to check with your pension scheme administrator), they won’t be subject to IHT.
It’s a fantastic way of mitigating inheritance tax and also passing on that to your beneficiaries tax free, although they will still be taxed at their marginal rate of income tax when they do withdraw funds. Or they can skip a generation and pass it down to their own children.
Gifting to friends and family
If you are concerned about your future inheritance tax (IHT) liability, you can gift assets to friends and family. You can give away £3,000 worth of gifts each year, exempt from IHT. You can also use the previous year’s unused gift allowance. As a couple that’s potentially £12,000 that they can get outside of their inheritance tax liability. You can also give £250 each year to as many people as you like.
If you wish to gift more than this amount, the 7 year rule comes into play. The taxable amount on gifts over the Nil Rate Band (currently £325,000) given within 7 years of death gradually reduces over time.
Contribute to Junior SIPPs
Friends and family can contribute £2,880 a year into a Junior SIPP on behalf of a child, and the Government will add tax relief at 20% to make this up to £3,600. If you are able to contribute a regular amount, it should be part of your ‘regular expenditure’ and not subject to IHT gifting rules. Contributing in this way could lower your IHT liability, because you’re not building any additional funds into your estate.
Financial planning as a couple
As an adviser, I’m often checking for possible complexity or opportunities in a client’s plans. A good place to start is whether they’re married or if their marital status has recently changed. For many, marriage can seem like it’s a bit of an old convention, but it does have an impact on financial planning. You can almost feel like you’re a matchmaker when you’re giving advice – because sometimes you have the conversation with committed couples about why they haven’t gotten married!
Let’s look at some of the rules that allow couples to benefit (see table below).
Married Couple Allowance
I think probably the first and foremost for making the most of your financial planning, I think of the Married Couple Allowance. Spouses are able to transfer up to £1,260 of their Personal Allowance to the other. The only problem with that is they have to be a basic rate taxpayer. It is not available to higher rate taxpayers, but it’s just a quick win for a lot of potential clients. It could save a couple £252 a year in tax.
Capital Gains Tax
Your spouse’s CGT allowance can be used for tax planning, by transferring potential gains to your partner. Let’s look at an example. Let’s say Jane and David are married. Jane is a higher rate taxpayer and David is a basic rate taxpayer. Jane has a portfolio of shares, which she is looking to sell so that they can go on a luxury cruise and complete some home improvements. If the sale of the shares realise a gain of £30,000. Neither has used their 2022/23 annual exemption (£12,300) and the intention is to sell the shares before the end of the 2022/23 tax year. If Jane goes ahead and sells the shares, she will realise a chargeable gain of £17,700 after deducting her annual exempt amount of £12,300. As a higher rate taxpayer, the gain will be taxed at 20%, giving rise to a CGT bill of £3,540 for Jane.
However, if Jane and David make use of their inter-spouse exemption to transfer shares, their position is very different. Jane is left with a gain of £12,300 which is covered by her annual exempt amount, leaving no CGT bill for Jane. David, however, is left with a chargeable gain of £5,400 (£17,700 – £5,400) after deducting his annual exempt amount of £12,300. As the gain falls within his basic rate band, it is taxed at only 10%. This would leave a CGT bill of £540 for David.
By making use of the inter-spouse exemption, Jane and David’s combined CGT bill would be reduced by £3,000. The Capital Gains Tax allowance is annual. So, Jane and David couldn’t roll over any unused allowance from a previous year. There are some allowances you can carry back, but it’s always a good idea to use them every year that you can. As you can see from this article, the UK’s financial planning landscape is complicated – and continues to evolve. You can find all the allowances and exceptions mentioned in this article on the HMRC’s website.
Wren Sterling also provides Budget and Spring Statement Reports, which come with the latest tax rates included, so you can stay up to date.
But the easiest thing is to talk to your Financial Planner and make use of their knowledge and expertise to discuss about your future plans and importantly, if your circumstances have changed, however minimal you might think the change is.