Tax is complex enough at the best of times but its intricacies are exacerbated among high earners
Taxation is a crucial factor when managing the finances of high-income clients. It is a complicated area, made even trickier by the fact there are many different variables that can affect the amount of tax owed.
The standard top rate of income tax is 45 per cent (46 per cent in Scotland). However, there are quirks within the system that can give rise to even higher rates.
For instance, the personal allowance is reduced by £1 for every £2 of adjusted net income above £100,000. This means an income of between £100,000 and £123,700 is taxed at up to 60 per cent, due to a combination of the loss of personal allowance and additional higher rate tax.
What is more, capital gains tax is payable on gains above the annual exemption. The individual rates of tax are 10 per cent for basic rate taxpayers and 20 per cent for higher rate taxpayers and, for gains on properties, 18 per cent and 28 per cent respectively. Entrepreneurs’ relief can apply where the assets are qualifying business assets, and tax is then reduced to 10 per cent.
Having paid tax on income and capital gains, the net money a client has managed to accumulate during their lifetime may then be subject to inheritance tax at 40 per cent on estates above the available allowances. Thankfully, there are legitimate ways of planning to reduce the tax payable.
Pensions offer the most efficient and flexible means of mitigating taxation.
Firstly, pension contributions provide income tax relief on the contributions paid.
Secondly, investment growth within the pension is tax-free.
Thirdly, the pension fund is outside of an estate for IHT.
Pensions can be used to recover any lost personal allowance and a similar scenario applies if income is over £50,000 and you face a child benefit tax charge.
Each year, most people can contribute up to £40,000 or 100 per cent of earnings (whichever is the lower) into their pensions, although individuals with taxable income over £150,000 can have their annual allowance tapered down to a minimum £10,000.
Different criteria can apply to company directors, as the firm can make potentially greater contributions on behalf of the director and can then offset the payment as a business expense to reduce corporation tax.
It is possible to carry forward unused allowance from up to three previous tax years, allowing for catch-up contributions if earnings fluctuate.
Pension funds held in discretionary trusts are outside of the estate for IHT and, under flexi-access contracts, are paid tax-free on death before age 75. Post-75,
the beneficiary is taxed at their marginal rate. High-net-worth individuals are also often affected by the lifetime allowance.
In addition to pensions, there are other tax-advantaged investment opportunities, the obvious being Isas. An overall allowance of £20,000 per individual per tax year can be invested in stocks and shares, and/or cash Isas. No income tax or CGT is payable on the interest, dividends or gains within them.
The following tax-efficient products can also provide benefits to high-net-worth individuals:
- Venture capital trusts. These offer 30 per cent income tax relief if held for five years, tax-free dividends, tax-free exit and no CGT on gains.
- Enterprise investment schemes. These offer 30 per cent tax relief, CGT deferral, tax-free exit on gains, no CGT on gains after three years and IHT-free after two years.
- Business relief schemes for IHT. Qualifying assets receive IHT relief after two years.
- Aim Isas. Investments receive IHT relief after two years, tax-free dividends and no CGT. Transfers into Aim Isas from existing Isas are unlimited.
High-net-worth individuals considering estate planning have opportunities to reduce the tax payable on their estate.
The nil rate band for IHT is currently £325,000. Married couples have unlimited spousal transfers between each other. Where a spouse dies and everything passes to the surviving partner, on the survivor’s subsequent death they will inherit their spouse’s NRB and have £650,000.
In addition to the standard NRB, there is now a main residence NRB, which is currently £125,000.
The RNRB will increase from 6 April to £150,000 and again on 6 April 2020 to £175,000.
The property must be left to a direct descendant of the deceased and the RNRB will be capped at the lower of the property value being gifted or the available RNRB.
On first death, if the RNRB is not used, it can pass to the surviving spouse. From 6 April 2020, up to £1m of NRBs could be available for the surviving spouse. Estates above £2m on death will lose the RNRB by £1 for every £2 above £2m.
Tax is undeniably complex and this can be exacerbated among high earners. Clearly, each individual’s situation is unique, so needs to be handled differently to ensure the best taxation planning possible.
There are a vast range of options to consider but, as of yet, no one-size-fits-all approach.
Noreen Walker is technical adviser at the SimplyBiz Group