Welcome to the March 2018 newsletter from Chamberlains
We’re nearly at the end of the tax year, but there’s still time to plan a few things to beat the 5 April tax deadline – hence this newsletter rather earlier in the month than normal. Specifically, have you used as many of your tax-free allowances as possible?
Some won’t apply to you, but the main ones are:
• Personal allowance – £11,500
• Capital gains tax allowance – £11,300
• Tax-free interest – up to £1,000
• Tax-free dividends – £5,000
• Rent-a-room allowance – £7,500
In addition, there are various types of savings opportunities with annual limits, notably pensions and ISAs, and also gifts that can be made without any effect on IHT.
Personal allowance – £11,500
We are all – even children – allowed this amount of income without paying tax. If you haven’t reached this amount, perhaps you could find a way of doing so! It may sometimes be possible to bring forward income from next year, for example. On the other hand, perhaps you’ve reached this level but not your partner – in which case could there be a legitimate way to transfer some income to them? In a business context, partners aren’t always paid as much as they could be for their contribution. However, it doesn’t work to give interest- or dividend-bearing investments to your minor children – the taxman treats the income as still yours.
Capital gains tax allowance – £11,300
Some people are fortunate enough to have a portfolio of assets that they can selectively sell. If these are now worth more than when they were acquired, you’d probably expect to pay capital gains tax. However, each tax year you’re allowed gains of up to £11,300 without having to pay any tax. Financial advisors (ask me for names!) are happy to suggest investments that gain in value rather than giving income – so-called “growth stocks”, for example. If a portion of these are sold each year to make use of the annual CGT allowance, there’s effectively an opportunity for another £11,300 tax-free income every year, no matter what your other income may be.
And if you’re married, you can pass assets between you tax free (although there may be stamp duty) so that you can each benefit from the CGT allowance.
Tax-free interest – up to £1,000
From the 2016/17 tax year onwards, basic-rate taxpayers have been allowed to receive interest of up to £1,000 without paying tax – which is why since April 2016 banks and building societies stopped deducting tax when they pay it to you. Good news, for a change! If you’re a higher rate taxpayer, you’re only allowed £500 tax-free, and if your income is over £150,000 the taxman doesn’t give you anything, ie. it’s £0 tax-free!
As a result, most people won’t need to pay any tax on their interest income. However, if you’re lucky enough to receive interest above these amounts, there’ll be extra tax to pay which would previously have been covered in part or in whole by the tax deducted before it reached you. This is done via your tax return, and HMRC is normally notified automatically by banks, so people have to make sure they don’t “forget” about it!
As a tax-planning point, you may like to check whether you want to update your building society book to make full use of the £1,000 before 5 April – or you may decide to defer it into the next tax year.
Tax-free dividends – £5,000 (soon to be just £2,000)
Similar to the tax-free interest, since April 2016 there have been tax-free dividends for everyone (higher rate taxpayer or not) up to £5,000. The previous system was that there was no further tax to pay on them anyway, unless they took you beyond the basic rate band – at which point you needed to pay a top-up to get the tax to the higher rate.
It’s nice to get the first £5,000 tax-free, but after that you have to pay extra tax of 7.5% or 37.5% if it takes you into higher rate tax. For most people, the £5,000 will more than cover their dividend income, but it means more tax for the owners of many small companies. For them, it was generally cheaper to pay themselves dividends than a salary (no National Insurance to pay). They now find that they have extra tax to pay. Dividends are still normally cheaper for them, but the advantage has narrowed.
However, from 6 April 2018, the tax-free £5,000 is falling to £2,000. So if you can manage to use your full £5,000 allowance before then, so much the better.
Rent-a-room allowance – £7,500
This allowance has existed for a long time, but it only increased to £7,500 from 6 April 2016 – it had previously stayed at £4,250 for years. The scheme lets you earn up to of £7,500 tax-free each year from letting out furnished accommodation in your home. It doesn’t just have to be a room – you can let out as much of your home as you want. However, it’s halved if you share the income with your partner or someone else.
If you have rent from your home-sharing of less than the £7,500, you don’t even need to put it on your tax return. However, if you earn more, you can deduct either the £7,500 or the actual costs, whichever is the higher. NB – you can of course include a proportion of mortgage interest – so the actual costs may well produce a lower figure for taxable rent.
Other things to consider before 5 April – ISAs and Pensions
Pensions, as I’ve often said, are among the best ways to save for the long term. As a reminder, when you put £80 into a pension, HMRC top it up to £100. So the £100 in your pension pot has cost you £80 – an immediate profit of £20 that gives you comfort if you see a stock market wobble. Higher rate taxpayers do even better – they put the £100 on their tax return and effectively get a tax refund of £20, so their £100 has only cost them £60!
If higher rate taxpayers want to benefit from this, to reduce their tax liability for a particular tax year, the pension payment must be made in that same tax year – hence the urgency to action it before 5 April. There are limits on the level of contributions, based on your earned income and with a ceiling of £40,000 – but unused allowances can be brought forward from previous years, provided your current-year earned income is sufficient. However, there are further restrictions If you earn over £150,000 or if your pension pot is likely to have a value of over £1,000,000. Too complicated to go into details now, but please let me know if you’d like more.
ISAs have become increasingly generous and flexible over the years. In the current tax year, you can shelter up to £20,000 – into cash, stocks and shares, or “innovative finance”, in any proportion. People between 18 and 39 can put up to £4,000 of this £20,000 into a “Lifetime ISA”. These are not only tax-free but the government gives a 25% bonus. However, these LISAs can only be used as a deposit for a first home or as the start of a retirement fund, whereas other types of ISA can be broken into at any time, subject to loss of interest etc. Once the funds are under the ISA umbrella, any related income or capital gain is tax-free – and ISAs can now be inherited by your spouse. You have to make the investment before 5 April to benefit from this year’s allowance, otherwise it’s wasted.
Given the low level of investment returns, and the tax-free system for interest and dividends (see above) there doesn’t seem to be such an incentive to use ISAs – but it doesn’t do any harm and psychologically the funds may feel safer stashed away like this. And those of us with sufficient in our pensions and substantial investment portfolios (not me, unfortunately!), are well-advised to make an annual transfer of the maximum into ISAs from their unsheltered investments.
Gifts to charities are cheaper if you’re a higher rate tax payer. They work a little like pensions if you’re a higher rate taxpayer. You pay £80 to the charity under Gift Aid and the charity claims another £20 from HMRC. So long as you pay tax of at least £20 on your income, that works well. If you don’t pay that much tax, HMRC have the right to claim the £20 back from you. However, if you’re a higher rate taxpayer, you enter the full (“grossed-up”) £100 on your tax return, and you get a further £20 back. So the £100 in the charity has only cost you £60.
For Inheritance Tax, substantial gifts can still form part of your estate, taxable for IHT unless you survive for seven years after the gifts. These are known as “potentially exempt transfers”. However, every tax year you’re allowed to give up to £3,000 with no IHT consequences (£6,000 if you made no such gift in the previous tax year).