End of year tax planning opportunities to look out for
Wednesday 19th January, 2022
The end of tax year is always a mad rush to try and utilise all our personal tax allowances and reliefs in order to ensure that our investment returns and income are generated as tax efficiently as possible. After all, the government makes a limited number of tax incentives and reliefs available to us and it makes sense to utilise them as much as possible.
This article aims to highlight some of the mainstream tax planning opportunities that are available and how to use them.
If you would like to discuss how you can make the most of these end of tax year planning opportunities, then please don't hesitate to give us a call.
As we rise from the wonderful, lazy malaise induced by the festive season, we are immediately confronted by the short, sharp shock that is the lead up to the end of tax year. In the frenetic lead up to Christmas and New Year, none of us really wants to give our finances a second thought. We then relax into the comforting haze of roasts, luscious puddings, crackers, port and Christmas TV and float to New Year.
However, as the strains of “Auld Lang Syne” fade into the distance, it’s as if someone suddenly pushes the fast forward button and we seem to be careening wildly towards April 5th. Suddenly, all our tax planning needs have to be crammed into this 3-month period. For investors it can be a very difficult period, as you phone up your adviser and say, “I would like to top up my pension/ISA” and a panicked voice from the other side of the phone says, “Sure, but I will need to see you in the next five minutes if we are to achieve it by the end of tax year deadline”.
For advisers, it is a nerve-wracking time, as many of our clients only find out their final bonus or dividend payments at the end of the tax year and there is a mad rush to get it all invested in suitable tax wrappers, amidst a shower of digital warnings from pension and ISA providers that there are only three more days before they cannot accept any new applications for this tax year.
I hope I have suitably illustrated the nerve-jangling thrill ride that is the end of tax year journey. The thing is, it doesn’t have to be this way. By having a good idea of the tax planning opportunities you would like to take advantage of, you can put a plan in place to get everything achieved as smoothly as possible. Even if you aren’t exactly sure of what your final bonus/dividend or level of pay is going to be, you and your adviser can put the ground work in place, and then add the numbers and make adjustments at the point that the figures become certain and the most suitable options crystallise.
In an ideal world, you should be signing application forms by the beginning of March. You may think that is a bit premature, but the reality is that between the three or four parties involved in many of these transactions, there is plenty of scope for error, so having time to address anything that crops up is really useful and cuts down massively on the need for last minute panics.
To help recognise the top tax planning opportunities and things to consider, I have created a list below. As always, if you feel that you would like to take advantage of one of these opportunities, then please don’t hesitate to give us a call.
Use ISA allowances
From a personal perspective, I think that utilising your ISA allowance each year is crucial and one of the most underrated opportunities available. Many people I know regard the ISA as small beer and fairly unimportant, but this is very short-sighted.
The ISA allowance is currently £20,000 per person per annum and if you don’t use it in the relevant tax year, you lose it. You can’t carry the allowance forward at all.
ISAs protect your investments from income tax and Capital Gains Tax and all withdrawals from the ISA are tax free. Furthermore, returns and withdrawals do not have to be declared on a tax return.
What does this mean for you, as the investor? Well, if you could build up £200,000 in ISAs over your working life (this would involve saving roughly £200 per month from ages 35 – 65 at a 5% per annum return) then this would allow you to sustainably withdraw up to £10,000 per annum, tax free, in retirement (5% x £200,000). It goes without saying that this is a theoretical exercise, but the principle is sound and it demonstrates the benefits of using an ISA.
It is also important to remember that there are already quite a few ISA millionaires out there, so it is perfectly feasible to build up large sums of money within an ISA wrapper.
Pensions offer several avenues for claiming tax relief or improving your tax position. These include:
- Maximising your own pension contributions
- Reclaiming your personal income tax allowance
- Carrying forward unused pension allowances
- Maximising your partner’s pension contributions
- Boosting pension savings now before retiring and triggering the Money Purchase Annual Allowance
- Sacrifice some of your bonus to make an employer contribution into your work pension
- Take profits from your business as pension contributions
- Recover your entitlement to child benefit
Maximising your own pension contributions
Contributions into pensions receive tax relief at your marginal rate of tax saving, therefore basic and higher rate taxpayers may wish to contribute an amount to maximise tax relief at 20% or 40%.
There have also been changes to the Tapered Annual Allowance for high earners, which can make pension contributions for additional rate tax payers (those with income of more than £150,000 per annum) very beneficial. Previously the annual pension allowance was reduced by £1 for every £2 that the individual’s “adjusted income” exceeded £150,000. The application of this taper could result in a high earner’s annual allowance being tapered all the way down from £40,000 to £10,000.
However, this was changed from 6 April 2020, and the new rules are that people with a taxable income over £240,000 will have their annual allowance for that tax year tapered, as described above. The maximum reduction is £36,000. So, anyone with an income of £312,000 or more has an annual allowance of £4,000.
What this means is that many additional-rate tax payers, who had their annual allowance dramatically reduced by the previous taper rules, can once again make a full gross contribution of £40,000 to their pension and claim the relevant tax relief at 45%.
Reclaiming your personal income tax allowance
There are similar benefits for those with income over £100,000, which is the point at which the personal income tax allowance of £12,570 starts being eroded by £1 for every £2 the income exceeds the £100,000 threshold. This can be quite galling, if you are someone who has worked hard to earn a high salary, only to lose some or all of your income tax allowance.
However, there is a solution. It is possible to reclaim the personal allowance by making a pension contribution that takes your income to below the £100,000 threshold at which you start to lose your personal allowance.
Carrying forward unused pension allowances
In cases where you may have received a windfall in the form of an inheritance or a sizeable bonus, it is important to remember that you can maximise the tax relief available from pensions by using carry forward.
“What is carry forward?” you may ask. Well, a pension differs substantially from an ISA in that unused pension allowance from the previous three tax years can be utilised in the current tax year, provided you have used the current tax year’s allowance first and you have high enough relevant UK earnings. The amount that you can contribute to a pension each year is limited by the lesser of your Annual Allowance or your UK relevant earnings.
Carry forward can also be useful in cases where your income exceeds the adjusted income limit, resulting in your Annual Allowance being tapered. In these circumstances, it is possible that you may be able to reinstate your full £40,000 allowance by making use of carry forward. The tapering of the annual allowance won't normally apply if income less personal contributions (i.e. contributions that are not made out of pre-tax income by the employer) is £200,000 or less. A large personal contribution using unused allowance from the previous three tax years can bring income below £200,000 and restore the full £40,000 allowance for the relevant tax year. However, this strategy comes with a lot of caveats and it is important to remember that the annual allowance available in the carry forward years will be based on income in those years and the lower adjusted income and threshold income limits of £150,000 and £110,000 respectively.
Maximising your partner’s pension contributions
It is quite common for one party in a couple to be a high earner, while the other is a basic rate or non-taxpayer. It is important to remember that it is also possible to top up the lower earners pension. Even if the partner doesn’t earn anything, it is still possible to make an annual contribution for them of £3,600 (gross).
Boosting pension savings now before retiring and triggering the Money Purchase Annual Allowance
This is an approach that you should consider if you are approaching retirement and are thinking of using flexible drawdown to fund your retirement, as opposed to the traditional approach of purchasing an annuity.
If you decide to use flexible drawdown, it is important to note that once you withdraw taxable income from your pension, it will trigger the Money Purchase Annual Allowance (MPAA) which will reduce the amount you can contribute to a pension each year to £4,000 per annum. The MPAA will apply to all pension contributions from the date of the first taxable withdrawal.
Triggering the Money Purchase Annual Allowance (MPAA) will mean the opportunity to continue funding into your Defined Contribution pensions will be restricted to just £4,000 a year. Furthermore, there is no carry forward allowed.
Therefore, if you are planning to retire at some point in the next tax year and then access your pension benefits flexibly, it makes really good sense to maximise your pension contributions in the current tax year, as the MPAA could dramatically reduce your capacity to do so in the next tax year.
Sacrifice some of your bonus to make an employer contribution into your work pension
As mentioned earlier, the tax year end often coincides with business year ends and, for some people, this could mean a bonus payment.
For these employees it can often make very good sense to “sacrifice” some of their bonus by asking their employer to rather contribute the sacrificed amount into their workplace pension.
This is a tax efficient strategy for both the employee and the employer, as both of them will not have to pay National Insurance on the contribution. Furthermore, the contribution will be made out of the employee’s untaxed bonus, so there is a potentially substantial tax saving there. For the employer, they can claim the pension contribution as a business expense and offset the contribution against corporation tax.
While there are potentially large tax efficiencies to be had from this approach, it is important to remember that this all needs to take place within the framework of the pension annual allowance provisions, so it is important to take some advice from a suitably qualified adviser before adopting this strategy.
Take profits from your business as pension contributions
For many business owners, taking profits as pension contributions could be the most efficient way of paying themselves and taking cash out of the business.
This is a remarkably efficient approach to withdrawing funds from a business. As mentioned earlier, if a business makes a contribution into a pension on behalf of one of its owners in their capacity as director, the contribution can be treated as a business expense by the business and offset against corporation tax.
Furthermore, the pension contribution is made to the pension free from National Insurance payments by either the owner or the business and the contribution is not subject to income tax.
If the director is over the age of 55, they can access the pension contribution to the pension immediately with 25% of it being tax free.
Recover your entitlement to child benefit
As highlighted earlier, Individual pension contributions can be used to reduce your taxable income below certain thresholds, thus improving your tax position.
A key example of this in operation is the Child Benefit provisions. Child Benefit is clawed back by a tax charge if the highest earning individual in the household has income of more than £50,000, and is cancelled altogether once their income exceeds £60,000. A pension contribution will reduce income and reverse the tax charge, wiping it out altogether once income falls below £50,000.
Take investment profits using Capital Gains Tax (CGT) annual allowances
Every one of us is entitled to a really valuable annual Capital Gains Tax (CGT) allowance of £12,300. Much like the ISA annual allowance, this will be lost if it is not used in the relevant tax year. It is therefore really important to, where possible, utilise this allowance and a key opportunity to do this is by taking gains achieved on unwrapped (not held in a pension, investment bond or ISA or other tax wrapper) investments.
This can be done by taking profits within the £12,300 CGT allowance each year and re-investing the proceeds. By doing this, you will tax efficiently realise at least a portion of the annual gain and there will therefore be less tax to pay when you ultimately need to access these funds to pay for your retirement or other spending goals.
Alternatively, you could look to supplement your income tax-efficiently each year by withdrawing gains from your portfolio and keeping the realised gains within the annual exemption.
When doing this, it is important to remember that proceeds cannot be re-invested into the same fund for at least 30 days, otherwise the expected gain will not materialise. But it can be re-invested in a similar fund or through your pension or ISA. As you can see, this can once again get relatively complicated, so it is important to take advice when doing this to make sure you do not fall foul of any of the relevant restrictions.
Using tax relief from Enterprise Investment Schemes to reduce tax
As the law currently stands, an investment of up to £2 million (provided that any amount above £1 million is invested in knowledge-intensive companies) can be made into an Enterprise Investment Scheme (EIS) and it will qualify for income tax relief at 30%. It is important to note that the amount of tax relief claimed cannot exceed the investor’s income tax liability for the relevant tax year.
An EIS investment can be carried back to the immediately preceding tax year to secure income tax relief in that tax year. It is also possible to roll over a CGT liability into the EIS and defer its payment, provided some of the EIS investment potentially qualifies for income tax relief.
This is all fine in theory, however the reality with EISs is that they can take upwards of 18 months for the full amount to be invested in EIS qualifying companies and a retail EIS can often invest across a number of different companies. As a result of this, the tax relief can become available in a piecemeal fashion over a long period of time. It therefore becomes far more difficult to immediately offset a tax liability.
In addition to this, EIS investments are by their very nature risky, as they are required to invest into new businesses. There is the option to utilise loss relief if the investment results in a loss and the 30% tax relief does provide further downside protection. However, this does not detract from the fact that these are very risky, with a higher-than-normal probability of loss. It is important that this risk is not obscured by the rather attractive tax benefits on offer.
Using tax relief from Venture Capital Trusts to reduce tax
Similar to the EIS, Venture Capital Trusts (VCT) offer income tax relief 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, as with an EIS investment, but dividends and capital gains generated are tax free. Many VCTs generate quite substantial dividends in excess of 5% per year, so these have the potential to generate a reasonable tax-free supplementary income, alongside your other income sources.
The advantage of the VCT over the EIS is that it is possible to claim the full 30% tax relief fairly quickly after the initial investment is made. This can allow you to have greater control over the timing of when the tax relief becomes available.
As with the EIS, VCTs are risky investments and it is important not to let the tax tail wag the investment dog, when considering their suitability.
Estate planning with your £3,000 annual exemption
Each of us is entitled to a £3,000 annual exemption, which allows us to make gifts of up to £3,000 per annum, which will be exempt from Inheritance Tax. 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 that year.
In the above article I have tried to highlight some of the most important and mainstream tax planning opportunities that are available. There may be others available that I have not touched on, but from my experience the above opportunities offer the biggest end of tax year wins.
While this article is timed to come out in the period running up to the end of the tax year, it is really important to note that tax planning with investments, pension, ISAs and various other options is a year-round task. This is the advantage of using a financial adviser who can actually take the time to put in place a plan which aims to maximise the tax efficiency of your various holdings regardless of the time of year or stage of life that you find yourself in.
If you would like to discuss any of the options highlighted above, then please feel free to give me a call to discuss it with you or book a free appointment via our website.
Please note: the value of investments can fall as well rise and you may not get back the amount originally invested.
The FCA does not regulate tax planning.