There are some clear benefits beginning to emerge from the changes to income tax – mostly in favour of the chancellor
I regularly find myself talking about tax planning in generic terms. And that is all good, but the generic has its roots in often granular specifics.
That is certainly true when it comes to the issue of income tax planning.
Some of the underlying rules are positively labyrinthine. I mean, dividend allowance, personal savings allowance and starting rate band?
The well-used phrase “well, I wouldn’t start from here” springs to mind. But, to coin another, we are where we are.
Understanding changes to income tax and their implications is pretty important.
Miss a couple and it probably would not be the end of the world. Miss a couple regularly and you can quickly have your knowledge anchored in the mists of time.
Not a great place to be for an adviser seeking to justify their fees on the basis of expertise and commitment to keeping financial plans appropriate.
So, let’s have a look at the latest income tax changes and what they mean, starting with the rates proposed for 2019/20:
- The limit for the starting rate for savings income remains at £5,000 and the rate of tax on income in this band is held at zero;
- The basic rate limit increases to £37,500, so the higher rate tax threshold (i.e. the basic rate limit [£37,500] plus the basic personal allowance [£12,500]) becomes £50,000;
- The basic rate of tax remains at 20 per cent and will apply to taxable income in the band £1 to £37,500. Dividends in excess of the £2,000 dividend allowance will be taxed at 7.5 per cent if they fall within the basic rate tax band. Taxable income in excess of £37,500 will be taxed at 40 per cent (32.5 per cent for dividends) up to the threshold of £150,000, when the additional rate of tax applies;
- The additional rate of tax (which applies to taxable income in excess of £150,000) remains at 45 per cent (38.1 per cent for dividends);
- Trustees of discretionary trusts are subject to income tax at 45 per cent (38.1 per cent on dividend income), on income above their standard rate band (normally £1,000).
Now for the personal allowances proposed for 2019/20:
- The personal allowance increases from £11,850 to £12,500. Where an individual’s adjusted net income exceeds £100,000, the level of the basic personal allowance will be reduced by £1 for each £2 over £100,000 until it reaches zero. This means that, in 2019/20, the basic personal allowance will reduce to zero where adjusted net income is £125,000 or more;
- The married couple’s allowance, which is only available provided at least one spouse was born before 6 April 1935, is increased to £8,915. There is a reduction in the MCA of £1 for every £2 additional income in excess of the total income threshold which is increased to £29,600. The MCA will not reduce below £3,450 (the “minimum amount”);
- Relief in respect of the MCA and maintenance payments continues to be given as a tax reduction at the rate of 10 per cent;
- Spouses and registered civil partners will be entitled to transfer £1,250 of their personal allowance (called the marriage allowance) to their spouse or registered civil partner provided that, after the transfer, neither spouse pays tax at above the basic rate.
The personal savings allowance is unchanged for 2019/20. Broadly speaking, this means that if an individual is a basic rate taxpayer, the first £1,000 of savings income will be untaxed.
If they are a higher rate taxpayer, the first £500 of savings income will be untaxed and if they are an additional rate taxpayer, they will not receive any personal savings allowance.
So how about planning in the light of all this? For all couples, as a bare minimum, both personal allowances, starting/basic rate tax bands and the dividend and personal savings allowances should be used to the full.
This is particularly beneficial where income can be legitimately shifted from a higher or additional rate taxpaying spouse to a non, starting or basic rate taxpaying spouse.
For those with cash and investments, this will usually be facilitated by an unconditional transfer of income-producing assets from the higher taxpaying spouse to the other.
Upon initial introduction in 2013, the take-up of the transferable marriage allowance was very low.
However, it has significantly increased since then and couples should ensure they do not lose out on the ability to transfer the allowance where eligible to do so.
Any such transfers would usually be capital gains tax and inheritance tax neutral, as those between spouses/registered civil partners living together are treated as transfers on a no gain/no loss basis for CGT purposes, and transfers between UK-domiciled spouses/registered civil partners (living together or not) are exempt from IHT without limit.
Devil in the detail
All well and good and, actually, pretty straightforward. Effective, tried and tested. Hardly anything revelatory…
That said, the introduction of the new £50,000 higher rate threshold has some interesting hidden consequences.
The chancellor’s Budget announcement that the personal allowance would rise to £12,500 and the basic rate band to £37,500 in 2019/20 came as something of a surprise.
Prior to that point, there had been suggestions he might have frozen both at this year’s level.
With the benefit of hindsight since, the consequences of the increases and the resultant £50,000 higher rate threshold are beginning to emerge. Here are a few:
- Reaching the 2017 Conservative manifesto targets for the personal allowance and higher rate threshold one year early has only a one-off cost, assuming they would anyway have been met in 2020/21. That is because there will be no increase to either the personal allowance or higher rate threshold in 2020/21, meaning that from then onwards the chancellor is working from the same personal allowance and higher rate threshold baseline for CPI indexation;
- The higher rate threshold increase is automatically carried across to the upper earnings limit for full rate National Insurance contributions. An employee earning £50,000 a year will save £860 annually in tax from the personal allowance and higher rate threshold uplift in 2019/20 but will simultaneously lose £340 – 40 per cent – in extra NICs;
- A £50,000 higher rate threshold now means the threshold at which the high income child benefit charge is triggered matches the end point for basic rate tax. Thus, someone with two children could be in the position where their marginal income tax rate (ignoring NICs, a de facto tax) goes from 20 per cent at £49,999 to 57.89 per cent from £50,000 to £60,000;
- A £12,500 personal allowance means the band of income triggering taper of the allowance will run from £100,000 to £125,000. See the table below for what marginal rates of tax will look like in 2019/20. While the effect for an additional rate taxpayer is the same as if all income between £100,000 and £150,000 were taxed at the old additional rate of 50 per cent, the overall result is better for the Exchequer because there will be more people in the first £25,000 of that band, paying a rate 10 per cent greater;
- The upper end of band earnings for auto-enrolment has risen to match the higher rate threshold at £50,000. Allowing for the lower earnings threshold rise of £104 (to £6,136), that means the band will widen by £3,546 (8.8 per cent) on an annual basis, just as the overall minimum contribution rate steps up from 5 per cent to 8 per cent. Worst hit will be someone earning £50,000 as their larger contributions will also come with 20 per cent rather than 40 per cent tax relief in the next tax year.
The Budget has heightened the case for saying the income tax system needs a drastic overhaul.
However, politics and a lack of spare money mean the UK will continue to limp along with a system built not on purpose but by the sundry tweaks of successive chancellors.
Tony Wickenden is joint managing director of Technical Connection (a St James’s Place Wealth Management group company). You can find him Tweeting @teccon