Tax-year-end planning for individuals
12 March 2019
23 September 2019
The run up to the tax-year end is a good time to consider tax planning to maximise the use of an individual’s allowances, reliefs and exemptions for the current tax year.
The run up to the tax-year end is a good time to consider tax planning to maximise the use of an individual’s allowances, reliefs and exemptions for the current tax year. Some of these will be lost if not used before the tax-year end. For those people who currently pay higher rate (40%) or additional rate (45%) income tax, tax planning is vital as a means of minimising the tax payable and maximising net income, capital gains and wealth.
In this article we briefly cover the main last-minute tax-planning opportunities open to UK resident individuals for tax year 2018/19 and look at strategies and disciplines which could be put in place to minimise tax throughout 2019/20.
While tax planning is an important part of financial planning, it is not the only part. It is essential, therefore, that any tax-planning strategy that is being considered also makes commercial sense.
In this article all references to spouses include civil partners and all references to married couples include registered civil partners. All tax figures quoted are UK excluding Scotland.
2. INCOME TAX
Tax saving opportunities are generally centred around maximising the use of allowances, reliefs and exemptions, and using tax-efficient investments.
(a) Maximising the use of all allowances, reliefs and exemptions
Each individual, regardless of age, is entitled to a personal allowance, starting rate band, basic rate band, personal savings allowance (PSA) and dividend allowance. It goes without saying that maximum advantage should be taken of each of these opportunities.
There is more scope to take advantage of tax breaks because both partners have their own allowances etc. Maximum tax-saving benefit can be secured where income/capital can be transferred from a higher or additional rate taxpaying spouse to a non or basic rate taxpaying spouse with generally no tax implications on the transfer.
The following points should be noted:-
- Couples should generally plan to maximise the use of both of their personal allowances. A non-working spouse will be able to receive earned income, including pension income, of £12,500 plus savings income of £6,000 (£5,000 zero starting rate band plus £1,000 personal savings allowance) and dividend income of £2,000, which means income of £20,500 for the tax year 2019/20 can be received before they pay any tax. Of course, where any earned income exceeds £8,632 (2019/20) there will be a National Insurance liability.
- Where possible, a couple should try to ensure that they both have pension plans that will provide an income stream in retirement that will enable them to use both their personal allowances.
- A spouse is entitled to transfer up to 10% of their personal allowance (£1,190 rounded for 2018/19 and £1,250 for 2019/20), which HMRC calls the “marriage allowance”, to their spouse provided that after the transfer neither spouse pays tax at the higher rate. This can save tax of up to £238 for 2018/19 and up to £250 for 2019/20. A claim can be backdated to include any tax year from 2015/16 in which a taxpayer was entitled to the allowance. If a claim is backdated now a lump sum of up to £900 could be received.
(b) The investment allowances available
(i) Personal savings allowance
Savings income that falls within the personal savings allowance (PSA) is tax free. For basic rate taxpayers the PSA is £1,000 a year, for higher rate taxpayers it is £500 a year, but no allowance is available for additional rate taxpayers.
‘Savings income’ in this instance is primarily interest, but it also includes chargeable event gains made on single premium bonds. Although called an allowance, in reality the PSA is a nil rate tax band so it is not quite as generous as it seems.
The PSA is available in addition to an individual’s personal allowance and £5,000 zero rate savings band and so, in theory, for a basic rate taxpaying individual with only savings income, they can receive in 2018/19 up to £17,850 tax free and £18,500 in 2019/20. Income within the PSA will use a part of the individual’s basic rate tax band.
(ii) Dividend allowance
All individuals are entitled to a dividend allowance of £2,000. Details of dividend taxation are given below, but all investors should seek to use their dividend allowance to maximise tax free income.
The main features of the allowance are as follows:
- A 0% dividend tax band of £2,000 for 2018/19 and 2019/20 for all individual taxpayers; and
- Tax rates at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers for dividend income in excess of the £2,000 allowance.
Like the PSA, the dividend allowance is really a nil rate band, so up to £2,000 of dividends do not disappear from tax calculations, even though they are taxed at 0%. From the viewpoint of an investor who pays tax at above the basic rate, the £2,000 dividend tax band is fairly generous.
One important point to note on this is the fact that it is the total dividend income of an investor that is taken into account in determining an investor's income for the purpose of the high income child benefit tax charge, standard personal allowance and adjusted income for pension tax relief and even to determine whether an individual is a higher rate taxpayer.
The 0% dividend tax band means that, regardless of their tax rates, a married couple can receive up to £4,000 of dividend income with no tax liability, provided that they share their dividends equally. Whilst this may not be necessary where £2,000 is sufficient to cover their individual dividend income anyway, they may wish to consider transfers of their investment portfolio to achieve an equal split.
The zero starting rate band
The starting rate band for savings income is £5,000 and the rate 0% for 2018/19 and 2019/20. This is available on top of the dividend allowance and personal savings allowance. The fact is that most people are not able to take advantage of the starting rate band; for example because a person’s earnings and/or pension income exceeds £16,850 in 2018/19. However, if a person does qualify, they will need to ensure they have the right type of investment income to pay 0% tax.
Using tax-efficient investments
The annual subscription limit is £20,000 and remains at this level in 2019/20. This means a couple could, between them, invest £40,000. A child aged 16 or 17 can invest £20,000 in a cash ISA in 2018/19 and 2019/20.
No tax relief is available on a subscription to an ISA but income and capital gains are free of tax. For those whose dividend income could exceed £2,000 (2018/19 and 2019/20), tax freedom on dividend income within the ISA will save tax at 7.5%, 32.5% and/or 38.1% as appropriate.
The attractions of an ISA are further enhanced by the continuing freedom from tax on income and gains arising during the administration period for the estate of an ISA investor who dies on or after 6 April 2018. If relevant, consideration should be given to making an additional permitted subscription to an inheritable ISA.
(b) Junior ISAs (JISAs)
Broadly speaking, JISAs are available to any UK resident child, under age 18, who does not have a Child Trust Fund (CTF) account. Any individual may contribute into a JISA on behalf of a child and the maximum subscription is £4,260 in 2018/19 and £4,368 in 2019/20. Such children aged 16 or 17 can also invest £20,000 pa in a cash ISA – see (a) above. The tax benefits are the same as for ISAs.
Children with a CTF account do not qualify for a JISA but, given its tax-free status, consideration should still be given to making further subscriptions to that CTF account or transferring it to a JISA. The maximum subscription to a CTF account is also £4,260 in 2018/19 and £4,368 in 2019/20.
(c) Growth-oriented collective investments
Given the relatively high rates of income tax as compared to the current rates of capital gains tax (CGT) it can make sense, from a tax perspective, to invest for capital growth as opposed to income.
Although income from collectives is taxable – even if accumulated - if this income can be limited so can any tax charge on the investment. Indeed, with emphasis on investing for capital growth, not only will there be no tax on capital gains accrued or realised by the fund managers, it should also be possible to make use of the investor’s annual CGT exemption on later encashment (or both annual CGT exemptions for a couple).
(d) Single premium investment bonds
Continuing pressure on the government to maintain high rates of tax means that deferment represents an important tax planning strategy and single premium investment bonds can deliver this valuable tax deferment for a higher/additional rate taxpayer. This is because no taxable income arises for the investor during the “accumulation period”.
In particular, it should be borne in mind that any UK dividend income accumulates without corporation tax within a UK life fund and realised capital gains suffer corporation tax at 20%. An investor in a UK bond will receive a basic rate tax credit for deemed taxation in the fund meaning that, on eventual encashment, a tax charge will only arise if the investor (after top-slicing relief) is then a higher rate or additional rate taxpayer.
More tax efficiency at fund level can be achieved via an offshore bond because there is no internal tax charge on investment growth and so it is possible to achieve gross roll-up. However, there is no basic rate tax credit for the investor on encashment.
(e) Enterprise Investment Scheme (EIS)
For tax years 2018/19 and 2019/20 an investment of up to £2 million (provided that any amount above £1 million is invested in knowledge-intensive companies) can be made to secure income tax relief at 30%, with tax relief being restricted to the amount of income tax otherwise payable by the investor. An investment can be carried back to the previous tax year to secure income tax relief in that tax year. Unlimited CGT deferral relief is available provided some of the EIS investment potentially qualifies for income tax relief.
(f) Venture Capital Trust (VCT)
The VCT offers income tax relief for tax years 2018/19 and 2019/20 at 30% for an investment of up to £200,000 in new shares, with relief restricted to the amount of tax otherwise payable by the investor. There is no ability to defer CGT but dividends and capital gains generated on amounts invested within the annual subscription limit are tax free.
3. CAPITAL GAINS TAX
As far as possible it is important to use the CGT annual exemption each tax year because it cannot be carried forward. Use of the 2018/19 annual exemption (£11,700) could result in a possible tax saving of £3,276 for a 40%/45% taxpayer and up to £2,106 tax for a basic rate taxpayer.
If a person is contemplating making a disposal in the near future, which will trigger a capital gain in excess of £11,700, it may be worthwhile, if possible, spreading the disposal across two tax years to enable use of two annual exemptions to be made. Alternatively, if the disposal cannot be spread or the gain is very substantial, the disposal could be deferred until after 5 April 2019 to defer the payment of CGT for a year until 31 January 2021.
Unfortunately, in using the CGT annual exemption a gain cannot simply be crystallised by selling and then repurchasing an investment – the so-called “bed-and-breakfast” planning - as the disposer must not personally reacquire the same investment within 30 days of disposal. However, there are other ways of achieving similar results:
- Bed-and-ISA. An investment can be sold, eg. shares in a collective investment, and bought back immediately within an ISA.
- Bed-and-SIPP. Here the cash realised on the sale of an investment is used to make a contribution to a self-invested personal pension (SIPP). The contribution is then invested in the investment that has been sold. This approach has the added benefit of income tax relief on the contribution and may also offer a higher reinvestment ceiling than an ISA, depending on a person’s earned income and other pension contributions.
- Bed-and-spouse. One spouse can sell an investment and the other spouse can buy the same investment without falling foul of the rules against bed-and-breakfasting. However, the sale of the investment cannot be to the other spouse – the two transactions must be separate.
- Bed-and-something similar. Many funds have similar investment objectives or, in the case of tracker funds, identical objectives. So, for example, if somebody sells the ABC UK Tracker fund and buys the XYZ UK Index fund, the nature of the investment and the underlying shareholdings may not change at all, but because the fund providers are different the transactions will not be caught by the rules against bed-and-breakfasting.
4. INHERITANCE TAX
Nil rate band
The nil rate band reached its current level of £325,000 in April 2009. It has been frozen since then and the freeze will continue until the end of the 2020/21 tax year. As a result of a frozen nil rate band more estates are dragged into the IHT net and, if a person is already caught, this adds to the amount of tax that will ultimately be levied.
IHT yearly exemptions
The extended nil rate band freeze makes the yearly IHT exemptions all the more important:
- The £3,000 annual exemption. Any unused part of this exemption can be carried forward one tax year, but it must then be used after the £3,000 exemption for the current year. So, for example, if a gift of £1,000 covered by the annual exemption was made in 2017/18, gifts totalling £5,000 can be made in 2018/19 by 5 April 2019, firstly covered by the annual exemption for 2018/19 and then using the remaining £2,000 exemption for 2017/18.
- The £250 small gifts exemption. An unlimited number of outright gifts of up to £250 per individual per tax year can be made free of IHT, provided that a recipient does not also receive any part of the donor’s £3,000 annual exempt amount.
- The normal expenditure exemption. Any gift that is made is exempt from IHT if: it forms part of a person’s normal expenditure; and taking one year with another it is made out of income; and it leaves the donor with sufficient income to maintain their usual standard of living.
If a gift is being made by way of a cheque to use a yearly exemption, remember that legally the gift is only made once the cheque is cleared. Friday April 5 is the final banking day of 2018/19 so any gift by way of cheque should be made before 1 April.
- The carry forward rules allow unused annual allowances to be carried forward for a maximum of three tax years. This means that 5 April is the last opportunity to use any unused allowance of up to £40,000 from 2015/16.
- For high earners, now is the final time to check, if they are subject to the tapered annual allowance, whether there is anything they can do about it. If the client has sufficient carry forward and their threshold income is only just above £110,000, making additional pension contributions could reinstate their whole annual allowance. This means more pension savings and the possibility of avoiding a tax charge.
- Making extra pension contributions not only increases pension provision but for those who may be subject to a reduced personal income tax allowance a personal pension contribution could claw back some of this allowance giving an effective tax saving of around 60%.
- In addition to helping high earners gain back their personal allowance, pension contributions can also help families get back their child benefit, which is progressively cut back if one parent or partner in the household has income of more than £50,000. Benefit is totally lost when income reaches £60,000.
- Individuals should consider making a net pension contribution of up to £2,880 (£3,600 gross) each year for members of their family, including children and grandchildren, who do not have relevant UK earnings. The £720 basic rate tax relief added by the Government each year is a significant benefit and the earlier that pension contributions are started the more they benefit from compounded tax free returns.
6. 12 QUICK NEW TAX YEAR TIPS
- Try to use the £12,500 personal allowance in 2019/20.
- Don’t forget the personal savings allowance, reducing tax on savings income.
- Make use of the £2,000 dividend allowance.
- Don’t ignore National Insurance contributions – they are really a tax at up to 25.8%.
- Think marginal tax rates – the system now creates 60% (and higher) marginal rates.
- ISAs should normally be a primary port of call for investments, and then deposits.
- Even if a person is eligible for a Lifetime ISA, they still might find a pension is a better choice.
- Tax on capital gains is usually lower and paid later than tax on investment income.
- Trusts can save inheritance tax, but also suffer the highest rates of capital gains tax and income tax.
- File a tax return on time to avoid penalties and the taxman’s attention.
- Never let the tax tail wag the investment dog.
- Don’t assume HMRC won’t find out: automatic exchange of information is spreading fast!
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.