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Use your tax allowances before 5 April deadline

Pension tax relief and capital gains tax allowance are too valuable to waste
March 28, 2018

With the end of the tax year on 5 April approaching, if you haven't already, take advantage of all the tax allowances that are appropriate for your circumstances. Many of these cannot be carried forward into the new tax year so it pays to use as much of them as possible each year.

Max your Isa

The annual individual savings account (Isa) allowance for this tax year and next tax year is £20,000. The advantage of holding your investments in an Isa means any income or growth is tax-free. And you don't have to declare your Isa investments on your tax return, which means no additional paperwork. But if you don't use your Isa allowance before 6 April it will be lost.

Over the next few weeks an investor could put £40,000 into their Isa in two chunks of £20,000 across the different tax years. You could also use your spouse or civil partner's unused Isa allowance by transferring some of your assets into their name, which they could put into an Isa. Transfers of assets between spouses and civil partners are not liable to tax, so a married couple using up their full annual Isa allowances in this tax year and next tax year could invest £80,000 in the next month.

If you don't have new money to fund your Isa this year but have assets outside a tax-efficient wrapper, you could transfer these into an Isa.

And if you are not sure what to invest in you could fund your Isa with cash and invest the money at a later date. However, this should be a short-term measure as holding cash offers little return.

Jason Chapman, managing director at Willis Owen, says: "The upcoming Easter weekend may offer the perfect moment to think about which fund choices you want to make. As ever, we urge investors to resist making snap decisions, base choices on their long-term goals and think twice about placing all their eggs in one basket."

 

Fill up your pension

Pensions are an effective way to save towards your retirement as contributions benefit from income tax relief at your marginal rate. Typically, you can make pension contributions that don't exceed your net relevant earnings in the tax year that you pay them, of up to £40,000. This is the maximum that you or your employer can contribute to all your pensions in one year without incurring a tax charge. 

Pension tax relief is particularly useful for higher and additional rate taxpayers who benefit from a boost of 40 per cent or 45 per cent, respectively. For example, a higher-rate taxpayer making a gross contribution of £40,000 would benefit from initial tax relief of £16,000, making their net contribution just £24,000.

But even non-taxpayers, including non-earning spouses and children, can make contributions of up to £2,880 into a pension and receive a top-up of up to £720.

However, if you earn more than £150,000, based on income from all sources, then the amount of tax relief you receive on pension contributions is tapered. This cuts the standard £40,000 annual allowance by £1 for every £2 earned above the £150,000 threshold. For instance, people who earn £210,000 and above are restricted to tax relief on contributions of just £10,000 per year.

If you are age 55 or over, and have already accessed your pension via drawdown or as a taxable lump sum, the amount you can subsequently contribute to a pension is limited to the money purchase annual allowance (MPAA) of £4,000. If you exceed this amount the excess will be subject to tax at your marginal rate.

Also make sure you don't exceed the pension lifetime allowance, which is currently £1m but rises by £30,000 to £1.03m from 6 April. If you put money into a pension above the lifetime allowance it will be subject to the lifetime allowance charge when you draw it as follows:

55 per cent if the excess is taken as a lump sum.

25 per cent if the excess is taken as income, for example as a scheme pension, an annuity or drawdown. Income tax at your marginal rate will also be payable.

In addition to using this year's annual allowance, you can carry forward any unused pension allowance from the previous three tax years. In theory, individuals who have not made any pension contributions during the previous three tax years could put £160,000 into their pension this tax year, depending on their earnings.

To carry forward you must make the maximum available contribution in the current tax year, which for most investors is up to £40,000. You must have earnings of at least the amount you are contributing. For instance, to make a contribution of £120,000 and receive up to £54,000 tax relief you must have earnings of at least £120,000 this tax year. Allowances from the oldest year are used up first, and at the end of every tax year the oldest year falls away. Any allowances not used from the oldest year, which is currently 2014-15, will be lost for good.

Andy James, head of retirement planning at Tilney Group, says: "The ability to carry forward can be extremely useful for those looking to catch up on pension contributions because they are underfunded, or because their financial position has improved and they are now in a position to do so. It is particularly useful for those whose current-year pension contributions are restricted by the tapered allowance because they have a total income over £150,000."

 

Consider alternative tax shelters

If you used up both your pension and your Isa allowances, and still have money to invest, you could consider government approved tax-efficient investment schemes such as venture capital trusts (VCTs) and enterprise investment schemes (EISs).

These both aim to encourage investment into small, unquoted companies which are high-risk investments. "There is a real danger that people invest in VCTs and EISs without understanding the risks," warns Patrick Connolly, certified financial planner at Chase de Vere. "These vehicles typically invest in small unquoted companies and can have very limited liquidity. They should only be used by those who have a diversified investment portfolio already in place, and understand and accept the risks."

But if you can stomach the risk and are prepared to lock your money away for at least five years, these could be helpful. Both schemes benefit from 30 per cent initial income tax relief plus free capital growth. VCTs pay tax-free dividends, which can be useful if you want to supplement your income. VCTs only raise a limited amount of money each year and shares are allocated on a first come, first served basis so you need to act quickly if you are interested as several offers have already closed.

If you reinvest gains in EISs you can defer capital gains tax. EISs can also be passed on free of inheritance tax if you have held them for more than two years. 

 

Don't forget your capital gains tax allowance

The capital gains tax (CGT) allowance for the current tax year is £11,300 and will rise to £11,500 next tax year. This is the amount of gain you can crystallise each tax year following the sale of assets without incurring CGT. Anything above this amount is charged at 10 per cent for basic-rate taxpayers and 20 per cent for higher-rate taxpayers.

Jason Hollands, managing director at Tilney Group says: "[The CGT] allowance is often overlooked by savers and investors, especially if they hang on to some favourite shares or funds for the long term. But this can mean the investment builds up a significant tax liability over time, which can be problematic when it comes to selling it."

A common problem is to build up CGT liabilities on assets that are much bigger than the annual allowance. To manage this, Colin Low, managing director of Kingsfleet Wealth, suggests selling off the assets in stages across different tax years. For example, a £20,000 gain could be crystallised in two portions of £10,000 so that it falls within your annual allowance over two years.

A married couple could both use their allowances to protect up to £22,600 of gains between them this tax year, and £23,000 next tax year.

It is also possible to reduce a potential CGT bill by offsetting any losses you have made on the sale of assets against the gains you have made. You can claim capital losses within four years of the end of the tax year in which they are made. Once you have claimed the capital loss it can be held indefinitely. This allows you to chip away at your gains by offsetting them against the loss until it is fully wiped out.

For example, Mr Low says a client who made a loss of £30,000 on an investment property was able to use that loss for six or seven years to offset the gains he made on the rest of his investment portfolio.

"If you have a capital loss you may want to crystallise it when markets are quite volatile," explains Mr Low. "The UK market has fallen around 10 per cent since its peak earlier this year and some people might be sitting on quite big losses. It's human nature to want to hold on to something and not sell it until you've made money on it, but by crystallising that loss you can offset it against gains."

Your CGT allowance can also be used to sell investments held outside an Isa which you subsequently repurchase within your Isa, offsetting any CGT against your annual allowance. This way your assets can grow tax-efficiently inside an Isa.

This is particularly relevant for investors who have large income-producing assets held outside a tax-efficient wrapper because from 6 April the amount of dividend income you can receive tax-free falls from £5,000 to £2,000. Any dividend income you receive above the new £2,000 a year threshold will be taxed at 7.5 per cent if you are a basic-rate taxpayer, 32.5 per cent if you are a higher-rate taxpayer or 38.1 per cent if you are an additional-rate taxpayer.