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Personal allowances

With the tax rate on savings income for basic-rate taxpayers at 20 per cent, the potential saving that can arise from a higher-rate taxpayer transferring funds to a basic-rate taxpaying spouse is 20 per cent, even though the real difference in their respective rates of tax is 18 per cent. Even greater savings can be obtained when the transfer is from a higher-rate taxpayer to a 10 per cent or non-taxpayer.

The following are the main taxation tips. Most of these need a full tax year to operate to give maximum effect, so these suggestions may serve as a reminder for planning for the coming tax year.

Everyone should try to 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 is a non-taxpayer or 10 per cent or basic-rate taxpayer and the other is a higher-rate taxpayer.

A non-working spouse can receive income of £4,535 this tax year and £4,615 next tax year before he or she pays any tax and the next £1,880 is taxed at only 10 per cent for 2001/02.

Where a working spouse owns investments, income from these may suffer income tax at a rate of up to 40 per cent or 32.5 per cent for UK dividends. Therefore, subject to practical considerations, the transfer of assets to a non-working spouse can save tax and increase overall investment returns. Such transfers must, of course, be outright and unconditional. Where possible, a couple should try to ensure that pension plans are set up for each of them so that the personal allowance of each can be used in retirement to ensure maximum tax freedom on the pension.

Since April 6, 2000, the married couple&#39s allowance has not been available for people aged under 65. However, it continues where one of a married couple was aged 65 or over on April 5, 2000.

For such married couples, for 2001/02, up to £1,035 of the allowance, which is due to the husband, can be transferred to the wife at her request or £2,070 of the allowance can be transferred to the wife if the husband and wife jointly so elect. Corresponding amounts for tax year 2002/03 are £1,055 and £2,110 respectively.

For such elderly people, an election must be made before April 6, 2002 if it is to be effective for tax year 2002/03. Relief for the married couple&#39s allowance is given at a flat rate of 10 per cent. This means if each of the couple are taxpayers, reallocation of the allowance is not going to produce a tax advantage. However, an election will produce a cashflow advantage if the husband is taxed under Schedule D and the wife under PAYE.

If a husband simply has insufficient income to use his allowance, any unused allowance can always be transferred to his wife.

An individual aged 65 or over benefits from an increased age-related allowance. However, this is cut back if his or her total income exceeds £17,600 (£17,900 for 2002/03). This limit applies separately to each of a married couple.

In the right circumstances, careful planning by transferring investment capital to rearrange income between spouses can improve tax efficiency. Alternatively, by using suitable investment products, the replacement of taxable income by non-taxable income or non-taxable withdrawals of capital can improve the tax position considerably. For example, withdrawals from a single-premium bond which fall within the annual 5 per cent allowance(s) will not count towards total income for age allowance purposes.

For persons engaged in a business, it can sometimes be worth considering the payment of a salary or a year-end bonus to a loweror non-taxpaying spouse, provided, of course, that he or she performs work for the business that justifies the payment. This could be at such a level as to ensure it is free of income tax and National Insurance, that is, currently not in excess of £87 a week (£89 a week for 2002/03). A pension payment can then be made in respect of this salary, meaning more tax saving now and into retirement.

Subject to very restrictive anti-avoidance rules where the parent is the donor, it is possible to make use of children&#39s and grandchildren&#39s personal allowances by establishing suitable trusts to which investments can be made subject. Where a parent creates a trust for a minor unmarried child and that child is entitled to income, for example, under a bare trust, if the income exceeds £100 gross in a tax year, it will be assessed on the parent regardless of whether it is distributed or accumulated.

This problem does not arise for other than a parental settlor. However, it must be remembered that even though, in such cases, when trust income exceeds £100 it will not be assessed on the non-parental settlor, no reclaim of UK dividend tax credits will be possible.

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