Each tax year each individual has allowances for Pension, ISAs and Capital Gains. If these are not used up before 5th April 2021 then they are lost. I am going to go into these in more detail below:
1. Pension Annual Allowances - £40,000 per annum
Each individual can make a tax relievable personal pension contribution of up to the lower of £40,000 per tax year gross or their total ‘relevant’ earnings (Employer contributions are not subject to the total earnings rule). This £40,000 is subject to the Tapered Annual Allowance but this only effects individuals earning over £200,000 in the tax year. A lower limit of £4,000 pa may also apply if you have already accessed your pension flexibly.
Each individual pension contribution receives basic rate tax relief of 20% of their gross contribution. (To easily calculate this, you add 25% to your net contribution). Therefore, to put in a contribution of £40,000 gross, an individual makes a net contribution of £32,000 which receives £8,000 of tax relief. Higher rate taxpayers (those earning above £50,000) will also be able to claim back higher rate tax relief on their contributions. This works by increasing the bands at which higher rate tax is paid by the amount of the gross pension contribution.
Everyone earning £100,000 pa or less has a tax-free Personal Allowance of £12,500 and then the next £37,500 is taxed at 20%, meaning everything over £50,000 is taxed at 40%. If they make a gross contribution of £40,000 as per above, then the £37,500 basic rate band increases by £40,000 meaning that 40% tax is not paid until earnings are above £90,000. This means that a higher rate taxpayer can get another 20% tax back and in the example above this means a further £8,000 of tax relief. This means a higher rate taxpayer can get back £16,000 of tax relief for a contribution of £32,000.
As well as the £40,000 per tax year, individuals can carry forward any unused allowances from the last 3 tax years (2017/18, 2018/19 and 2019/20) as long as they have had a UK pension in these tax years or prior to these tax years. This means that you could technically have up to £160,000 you can tax efficiently put into a pension before 05/04/2021. You will lose any unused allowances from 2017/18 on 5th April 2021 as this will fall outside of the 3-year window. For more information on carry forward please contact us directly.
Pension contributions can also be used to help keep your Child Benefit Allowance, which is reduced by £1 for every £2 you (or your partner) earn over £50,000. An individual’s ‘adjusted net income’ would be reduced by the gross amount of the contribution, meaning that you do not have to pay back any of this benefit if your deemed income fell back below £50,000 as a result of the pension contribution.
The most tax efficient use of pensions are for individuals earning between £100,000 and £125,000 per annum. Individuals lose their tax-free Personal Allowance of £12,500 at a rate of £1 for every £2 they earn above £100,000. (A person earning £110,000 will lose £5,000 of their personal allowance). Due to this, individuals will technically pay a rate of 60% tax between £100,000 and £125,000. A pension contribution can therefore be especially beneficial here as an individual earning £125,000 per annum will receive £6,344.96 per month net, if they salary sacrificed £25,000 into their pension their pay is reduced to £5,553.29 per month net. This means for £791.67 less per month in their hands they can have £25,000 paid into their pension.
2. Individual Savings Accounts (ISAs), Lifetime ISAs and Junior ISAs - £20,000, £4,000 and £9,000 per annum respectively
An ISA is a tax efficient savings wrapper. You can invest in a variety of different things such as Cash or Stocks and Shares and all income and gains from this are completely tax free. Each individual over the age of 18 (16 for Cash ISA’s) has an allowance £20,000 per tax year. An ISA can save you from paying unnecessary tax on your cash savings. (Please see here for tax on savings). Unlike the pension above there is no carry forward of unused allowances meaning that once this tax year ends your £20,000 allowance is lost forever if it has not been used up. The decision of what to invest in will be subject to a personal recommendation based on your risk and objectives.
As per above the Lifetime ISAs are completely free of any tax on income or gains. The Lifetime ISA replaced the Help to Buy ISA and in a lot of ways it is a better product. You must be over 18 and can invest up to a maximum of £4,000 per tax year. With the Lifetime ISA you are paid a 25% bonus from the government on all contributions. Whilst you must be under 40 to open a Lifetime ISA, you can continue to contribute up until age 50. The bonus will be paid in monthly. This means if you pay in your maximum £4,000 per annum then you will receive a £1,000 bonus. The amount invested in a Lifetime ISA comes off your main ISA allowance (if you put £4,000 into a Lifetime ISA then you can only put a further £16,000 into a normal ISA.) You can access money in your Lifetime ISA, including the government bonus and without paying any tax if:
You’ll pay a withdrawal charge if you take money out for any reason other than the three mentioned above. The charge is 25% of the amount withdrawn. If you invested £1,000, you’d have a total of £1,250 to take out. The 25% penalty charge is £312.50, so you’d only get £937.50 back, meaning you’d lose some of your savings and get back less than you invested. A Lifetime ISA is only suitable if you want to use it to help buy your first home, or to save for retirement. It can be a very useful and tax efficient tool for parents wanting to fund a first home deposit for their children. You must have held a Lifetime ISA for a minimum of 12 months to take the money out without a charge. This applies from the date you start a Lifetime ISA, so it may be important to start a Lifetime ISA as soon as possible as it gives you options to top this up in the future.
A Junior ISA has the same tax efficient rules as an adult ISA above but is for children up to age 18. You can invest up to a maximum of £9,000 per tax year. A child’s parent or legal guardian must open the Junior ISA account on their behalf and money in the account belongs to the child, but they can’t withdraw it until they turn 18, apart from in exceptional circumstances. The child can manage the money from age 16. When your child turns 18, their account is automatically rolled over into an adult ISA. They can also choose to take the money out and spend it how they like – for example, on driving lessons, further education, job training or move it into a Lifetime ISA as per above and get a 25% bonus if used toward first home or retirement.
A Junior ISA can be invested in cash or Stocks and Shares and any monies invested in Child Trust Funds (CTF) can be transferred from the CTF to a Junior ISA. From age 16 to 18 the child can put £9,000 into a Junior ISA and also up to £20,000 into a Cash ISA, meaning for these 2 years they technically have an annual allowance of £29,000 per tax year.
3. Capital Gains Tax Allowances
Each individual has a Capital Gains Tax allowance of up to £12,300 per tax year until they must pay any taxes. This means that spouses can have gains of up to £24,600 per tax year before any Capital Gain taxes are due. Capital Gains Tax (CGT) is a tax on the profit when you sell or gift something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive. This will apply to any houses you sell other than your main residence, shares and other investments.
This means that you can make up to £12,300 or £24,600 jointly on investments outside of an ISA, such as a General Investment Account, without any tax being due. It is important that these are managed properly to make sure you are using up your allowances each year (the gain must actually be ‘realised’ and this may lead to investments moving to cash inside the account and therefore not invested for a short time). By doing this each year you can build up a large tax- free portfolio to complement an ISA portfolio.
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