Make sure you’re making the most of your savings and investments before its too late. This means using all the tax free allowances you’re entitled to, choosing the right ISA for your needs and checking that all your smaller financial decisions are working together to benefit you.
Which ISA is best for you?
ISAs are a marvellous tax free option, but you need to pick the one that serves you best. You’re allowed to save up to £20,000 every year tax free. But this is fixed to each tax year. You can’t carry forward an ISA allowance, it’s gone for good on April 5th.
- Cash ISA: These are best if you’re saving for something that’s within the next five years. They have the lowest interest rates, so you won’t get as good a return.
- Stocks and Shares ISA: This type of ISA is best for long term investments that can get you a much higher return, over the same number of years, than a cash ISA.
- Lifetime ISA: This is a good choice if you’re saving for a deposit on your first home. You can save up to £4,000 tax free every year and get 20%/25% government bonus on top. There are strict withdrawal rules, but there’s no penalty if you use the money to buy your first property.
Lifetime ISAs must be opened by the time you’re 40 years old and can only be drawn on (without a fine) when you hit 60. The exceptions are buying your first house or extreme ill health. If you take your money out of a Lifetime ISA for any other reason, at any other time, you need to know that the exit penalty is going up to 25% in April.
There’s also a type of transaction called a ‘Bed and ISA’, which can be a way to put investments into an ISA. You sell the investment, straightaway put the money from the sale into an ISA and buy back the same investment through the ISA. Depending on the platform you use, you can also save money on the dealing charge.
This Bed and ISA helps you to make the most of the tax benefits of an ISA, when you don’t have the spare cash to open one. The only Capital Gains Tax liability you have on this transaction is any money you make on the first sale of the investment while its outside the ISA ‘wrap’.
Now’s the time to consider the role an ISA could play in your financial situation and put things in place before the end of the 2020-21 tax year. Don’t lose your allowance.
Are you making the most of your tax free pension allowance?
The 2020-21 annual pension allowance is £40,000 combined contributions of you and your employer. You don’t have to pay income tax or capital gains tax on your pension savings up to this amount.
Unlike your ISA allowance, your pension allowance can be carried forward for up to three years. So you need to make sure you’ve maximised this possibility.
Your pension savings are subject to tax relief at the rate you pay income tax. Most people get automatic tax relief on their pension savings of 20% the basic rate of income tax. If you’re in the higher or additional rate tax bracket you’re entitled to reclaim the additional percentage. For higher rate taxpayers, this is an extra 20%, to take the total tax relief up to the 40% tax rate you pay. If you’re an additional rate taxpayer, you can claim another 25%, to match your 45% income tax liability.
This becomes a top up to your pension of, at least 20p for every 80p you save. To look at it another way, if you’re a higher rate taxpayer, every £1 you save into your pension only costs you 60p.
What about your dividend income?
There is a current dividend allowance of £2,000 per year. And if your dividend income doesn’t take you over the Personal Allowance threshold, then you don’t pay income tax on it. But otherwise, unless it’s in a pension or ISA wrap, dividend income is taxable.
Anything over the dividend allowance is taxable at 7.5% for basic rate taxpayers, 32.5% for higher rate taxpayers and 38.1% for additional rate taxpayers. Have you got yours where you want it?
Put money into your pension instead of losing your Child Benefit or Personal Allowance
You’re entitled to claim child benefit, regardless of your income, as soon as you become a parent. But there is a ceiling on the income part of the calculation.
When your earnings hit £50,000, your Child Benefit decreases by 10% for every £1,000 you earn over £50,000 per year. This means that when you reach £60,000 annual income, your child benefit is reduced to zero. If you’re a couple, this applies when one of you starts earning over £50,000, even if the other partner doesn’t earn a penny.
In order to avoid losing this benefit, you can put some of your earnings into your pension. The Child Benefit calculation is based on the amount of your salary, minus pension savings. So, if you put enough extra into your pension to bring your salary to £49,999, then you’ll continue to receive your full Child Benefit entitlement. Alternatively, you can donate an amount to charity that keeps your income under the £50,000 threshold.
You can do the same things to keep your full Personal Allowance under the £100,000 threshold. Once you hit this annual income, your Personal Allowance amount goes down by £1 for every £2 over £100,000. By the time you earn £125,000, your Personal Allowance is reduced to £0. To retain your Personal Allowance, you need to keep your annual income under the threshold. Work out how much you’re over and either pay that amount into your pension or donate it to charity of your choice.
Are you using your Capital Gains Allowance effectively?
The 2020-21 annual Capital Gains Allowance is £12,300. This means that you can earn up to £12,300 from your non-ISA investments without paying any tax. That’s a substantial tax saving for investors and you can’t carry it forward into future years.
Once you earn over the annual Capital Gains Allowance, your investment earnings are taxed at either 10% for Basic Rate taxpayers, or 20% for Higher Rate taxpayers. If you’ve made your gains from selling a second property, you’ll pay an extra 8% tax on top.
Time to look at your investment earnings and use your Capital Gains Tax before you lose it on 5th April. Bear in mind that Capital Gains Tax allowance is for each individual person. So you use your civil partner or spouse’s Capital Gains Tax allowance by transferring your investments into their name.
Have you thought about Lifetime gifts or savings for children?
These are two other ways to keep yourself as tax efficient as possible.
Lifetime gifts of cash are called Potentially Exempt Transfers (PETs) and everyone has an annual gift allowance. The current allowance amount is £3,000. What’s great about this allowance is that you can carry it forward to the next tax year, if you haven’t used it all up.
You can also give money to another individual tax free, as long as it totals less than £250. Part of the PETs regulations state that if you die within seven years of giving a cash gift, inheritance tax may be chargeable.
Savings accounts for children have excellent tax allowances that you can use to optimise your tax position. For example, you can put £9,000 per year into a Junior ISA. This isn’t accessible until they are 18 and then the account automatically becomes a normal ISA where they are the account holder.
There’s also a Junior SIPP option. You can save a tax free £2,800 into that every year, which becomes £3,600 when you add in the tax relief. This kind of investment can’t be touched until your child is 57, so compound interest returns have plenty of time to mature.
You’ve still got time to make the most of these tax saving options before our current tax year comes to an end. It’d be a shame to miss out on any of your entitlements.
