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 which will be lost if not used before the tax year end. Now is also a good time to put in place strategies to minimise tax throughout 2014/15.
In 2014, year-end planning involves the usual mix of regular to-do items and one-off factors. In this article all references to married couples include registered civil partners.
There are four main income tax factors that are relevant for 2013/14:
1: The basic personal allow-ance is £9,440. This is due to increase to £10,000 in 2014/15.
2: The basic rate limit is £32,010, which reduces to £31,865 in 2014/15.
3: A 45 per cent tax rate applies to taxable income that exceeds £150,000.
4: People with income of more than £100,000 lose some or all of their basic personal allowance. The reduction is £1 for every £2 of income above £100,000.
People with income falling within categories three or four above pay marginal rates of income tax of up to 60 per cent on some of that income.
Increases in the amount of tax payable can be combated in a number of ways including:
- Maximising use of a couple’s allowances, reliefs and exemptions.
- Using tax-efficient investments.
MAXIMISING THE USE OF ALL OF A MARRIED COUPLE’S ALLOWANCES, RELIEFS AND EXEMPTIONS
Planning to maximise the use of a married couple’s allowances, reliefs and exemptions is very important for those whose top rate of income tax is 45 per cent. For such people who are married, the tax savings available by diverting income into the lower income earner’s name will be substantial. The tax savings that can arise from such planning can be similarly important for the higher rate (40 per cent) taxpayer who is married to a lower rate or non-taxpaying spouse. Diversion of any income must be on an outright and unconditional basis ie with “no strings attached”.
Similar planning may be appropriate for couples where one has income between £100,000 and £118,880. Where an individual’s adjusted net income is above the income limit of £100,000, the basic personal allowance will be reduced by £1 for every £2 above the income limit. Based on the basic personal allowance of £9,440 for 2013/14, an adjusted net income of £118,880 or above would mean that no personal allowance is available and non-dividend income in that £18,880 band is effectively being taxed at 60 per cent.
Most of these strategies need a full tax year to deliver maximum effect so these suggestions may serve more as a reminder to plan ahead for the coming tax year than as a “last minute” means of saving tax this year. In this respect, in 2014/15, the basic personal allowance will be £10,000 and so some or all of the personal allowance will be lost if a person’s income is in the band between £100,000 and £120,000.
The appropriate type of tax planning to adopt will depend on the type of income a person enjoys, that is, earned/business income
or investment income.
Individuals who have earned/business income falling into the £100,000 – £118,880 band could consider reducing this by paying a pension contribution or arranging for a salary sacrifice.
With the marginal rate of tax in the £100,000-£118,880 band of earned/business income being 60 per cent, it may thus be possible to obtain 60 per cent tax relief on some pension contributions.
Where an individual has investment income that causes their adjusted net income to fall into the £100,000-£118,880 band then, depending on their circumstances, any of the following may be appropriate strategies:
- Redistribution of investment capital to a spouse with a lower income so that the income generated is taxed on them instead.
- Reallocation of dividend income for couples who run their business through a company.
- Reinvestment in tax-free investments, such as an Isa, so that taxable income is replaced with tax-free income.
- Reinvestment in tax-efficient investments that generate no income and so will not impact on the loss of the personal allowance.
Such investments would include:
(i): Unit trusts/Oeics geared to producing capital growth.
(ii) Single-premium investment bonds from which a 5 per cent tax-deferred withdrawal may be taken each year, for 20 years, without affecting the personal allowance calculation.
Where possible, a couple should try to ensure that they both have pension plans that will provide an income stream in retirement which will enable them to both use their personal allowances.
Clients should make maximum use of all personal allowances available to them and their family. A husband and wife each have their own personal allowance. This is particularly relevant where one spouse pays tax at a lower rate than the other. A non-working spouse with no investment income will be able to receive income of £9,440 for tax year 2013/14 (£10,000 for 2014/15) before they pay any tax.
Older married couples benefit from an increased age-related personal allowance of £10,500 for 2013/14 and 2014/15 for those born between 6 April 1938 and 5 April 1948, and £10,660 for 2013/14 and 2014/15 for those born before 6 April 1938. It may be advisable to transfer income-producing assets between couples where one would otherwise exceed the current age allowance income limit of £26,100 (£27,000 for 2014/15) although with the substantial increase in the basic personal allowance, the extra savings available on utilising the full age allowance are now more marginal.
USING TAX-EFFICIENT INVESTMENTS
For 2013/14, the annual contribution limit is £11,520, of which no more than £5,760 can go into cash. This means a couple could between them invest £23,040. For 2014/15 the annual contribution limit rises to £11,880. A child aged 16 or over can invest £5,760 into a cash Isa in 2013/14 and £5,940 in 2014/15.
No tax relief applies on an investment into an Isa but income and capital gains are free of tax. As the dividend tax credit is not recoverable, for the basic-rate taxpayer an Isa invested in equities gives no income tax advantage. However, for a 40 per cent taxpayer, tax freedom means the net dividend income yield improves by 33.3 per cent and for a 45 per cent taxpayer by 44 per cent.
Investors who are 45 per cent taxpayers are more likely to be utilising their annual CGT exemption on a regular basis and so, for them, investment in an Isa is almost essential.
Broadly speaking, Jisas are available to any UK resident child, under age 18, who does not have a child trust fund. Any individual may contribute into a Jisa on behalf of a child, the maximum contribution is £3,720 this tax year (£3,840 in 2014/15) and the tax benefits are the same as for Isas.
Children with a CTF do not qualify for a Jisa but, given its tax-free status, consideration should still be given to paying further contributions to that CTF, especially as the Government has intimated that it will be possible to transfer a CTF to a Jisa with effect from 6 April 2015. The maximum contribution to a CTF is also £3,720 this tax year and £3,840 next tax year.
Growth-oriented unit trusts/Oeics
Given the relatively high rates of income tax compared with the current rates of 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 can be limited so can any tax charge on the investment. Instead, with emphasis on investing for capital growth, not only will there be no tax on 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).
Single-premium investment bonds
Continuing pressure on the Government to maintain high tax rates 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. Realised capital gains (after indexation allowance) suffer corporation tax at 20 per cent. 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.
Maximum investment plans/ Qualifying savings plans
Although the underlying fund of the MIP/QSP is taxed, the proceeds at maturity (usually after 10 years) are generally completely tax-free for the investor, irrespective of amount. However, the funds are not easily accessible before the expiry of 10 years. The scope to pay substantial premiums to MIPs/QSPs has been dented by the introd-uction, from 6 April 2013, of a limit of £3,600 per annum on payments to qualifying policies that commenced on or after 21 March 2012.
Enterprise Investment Scheme
For tax year 2013/14 an investment of up to £1m can be made to secure income tax relief at 30 per cent, with tax relief being restricted to the amount of tax otherwise payable by the investor. The relief can be carried back to the previous tax year. Unlimited CGT deferral relief is available provided some of the EIS investment potentially qualifies for income tax relief.
Venture capital trusts
The VCT offers income tax relief for tax year 2013/14 at 30 per cent 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.
CAPITAL GAINS TAX
There are four very effective forms of CGT planning as follows:
Using the annual CGT exemption
For individuals, the annual exemption is £10,900 for 2013/14. For higher and additional-rate taxpayers use of the annual exemption can save up to £3,052 in tax. For a basic-rate taxpayer, the tax saving is worth up to £1,962.
As far as possible, it is important to use the annual exemption each tax year because any unused exemption cannot be carried forward. Unfortunately, a gain cannot simply be crystallised by selling and then repurchasing the same investment – 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 such as “bed-and-Isa”, “bed-and-Sipp” and “bed-and-spouse”.
Maximising the use of a couple’s exemptions and lower tax rates
As the value of the annual CGT exemption depends on whether an individual is a higher rate taxpayer or not it makes sense for an individual who is a higher/additional rate taxpayer to transfer assets into their spouse’s name to utilise that spouse’s annual exemption on subsequent disposal. This can be achieved by an outright and unconditional lifetime transfer. This should not normally give rise to any inheritance tax consequences or CGT implications.
Indeed, it may even be worthwhile transferring an asset showing a gain of more than £10,900 if the result would be for the surplus capital gain to be taxed at 18 per cent rather than 28 per cent.
Pension contributions to reduce the tax on capital gains
Those who are realising a taxable gain may have taxable income around the basic-rate limit (£32,010 for 2013/14). This means that a significant part of any taxable gains is likely to suffer CGT at a rate of 28 per cent (because when added to taxable income, gains cause the basic rate limit to be exceeded). By taking action to increase the basic rate limit, it is possible for such a person to save CGT.
One method of achieving this is to pay a contribution to a registered pension scheme as the basic-rate limit is treated as being increased by the amount of the gross contribution.
If a person is contemplating making a disposal it may be worthwhile, if possible, to spread the disposal across two tax years to enable use of two annual exemptions. Alternatively, the disposal could be delayed until after 5 April 2014 to defer the payment of CGT until 31 January 2016.
Some businesses have year ends either on 31 March (corporates) or aligned with the end of the tax year (unincorporated businesses). In view of this, the lead up to the tax year end is traditionally the busiest for pension contributions. The end of the current tax year is likely to be especially busy as a result of some of the pension changes that we know will happen on 6 April 2014.
- The standard lifetime allowance will be reduced from £1.5m to £1.25m from 2014/15.
- A new form of protection – fixed protection (FP2014) – is now available. An election for this will enable an individual to take benefits of up to the greater of the standard lifetime allowance and £1.5m without any lifetime allowance charge. Features of FP2014 are that the individual must elect by 5 April 2014 and any protection will be lost where further pension accrual (usually above CPI) occurs or contributions are made after 5 April 2014.
An option to elect for individual protection will also be introduced. This will:
- Provide an individual with a protected lifetime allowance of the value of benefits at 5 April 2014 up to £1.5m provided benefits have a value of at least £1.25m.
- Enable contributions/pension accrual to continue after 5 April 2014. Election for individual protection cannot be made until after 5 April 2014 and must be made before 6 April 2017. The annual allowance will be reduced from £50,000 to £40,000 from tax year 2014/15. However, the annual allowances for tax years 2011/12 to 2013/14 remain at £50,000 for the purposes of calculating unused relief. An election for individual protection cannot be made until after 5 April 2014 and must be made before 6 April 2017.
The changes to the lifetime allowance will mean that anyone likely to be affected by the reduction, and looking to retire in the near future, will need to consider all means to reduce/avoid any lifetime allowance charge. This could include:
- Electing for fixed protection and/or, if appropriate, individual protection. This should include individuals aged under 75 in receipt of drawdown pension, if they feel a future benefit crystallisation test at age 75 may result in them exceeding the reduced £1.25m lifetime allowance. Considering drawing some or all their benefits before 6 April 2014 when these will be set against the current £1.5m lifetime allowance. For example, if an individual crystallised benefits with a value of £750,000 in March 2014 this would only use up 50 per cent of their lifetime allowance whereas if they left this until 2014/15 it would use up 60 per cent of their allowance.
- Considering how the benefits are taken. For example, an individual with money purchase benefits may well find that using their fund to purchase a scheme pension rather than a lifetime annuity may reduce the percentage of the lifetime allowance they used up. Similarly, a member of a defined benefit scheme should consider the difference in the lifetime allowance used where they draw their benefits solely as a pension or as a tax free cash sum with a reduced pension.
Annual allowance and carry forward
The reduction in the annual allowance from £50,000 to £40,000 from 6 April 2014 is somewhat softened by the ability to carry forward unused annual allowances based on a maximum of £50,000 for, currently, each of tax years 2010/11 to 2013/14. However, once introduced, the new limit is likely to be particularly onerous for members of defined benefit schemes with long past service.
For example, it will only need a real increase in pension entitlement (ie usually above CPI) of more than £2,500 to trigger an annual allowance charge (assuming the member had no carry forward entitlement).
People affected should act now to maximise the ability to pay contributions to registered pension schemes. Using the carry forward rules is likely to be particularly attractive to those clients whose contributions were restricted in tax year 2010/11 as a result of the special annual allowance, especially if they are now 45 per cent taxpayers.
When mopping up unused relief by paying a maximum contribution, it is clearly important to confirm that the pension input period end date falls in the “right” tax year.
The tax year end is a good time to generally consider a client’s IHT position, with a view to making larger gifts. Where ongoing control of the assets gifted is required, a discretionary trust will be useful but care should be exercised not to exceed the available nil rate band. If the investor needs access and IHT efficiency, a loan trust or discounted gift trust should be considered.
All those who are concerned about IHT should seek to use their available £3,000 annual exemption(s) before the end of the tax year. Any unused amount can be carried forward for one year only.