Planning for +£50,000 tax-free annually
Nobody likes paying tax, but luckily our tax system offers legitimate opportunities to diminish tax payments. Clients can enjoy a substantial level of tax-free income by taking advantage of the various allowances within the tax system…and it’s not that technical.
By carefully preparing and planning a multi-wrapper solution for clients with capital/disposable income to invest, we can help them achieve in excess of £50,000pa tax-free.
Let’s look at the allowances for 2019/20:
Income Tax Personal Allowance and Basic Rate Limits
- Personal Allowance (PA) is £12,500, income limit for the PA remained at £100,000
- Income tax rates stay at 20%/40%/45%
- Basic rate tax band increased to £37,500 except in Scotland, where differing rates apply for non-savings, non-dividend income, for more information on this please refer to this page.
- Additional rate tax band remained at £150,000
Capital Gains Tax
The CGT Exemption increased to £12,000 but the rates remained at 10% for gains within any remaining basic rate band & 20% thereafter. Capital gains on residential properties (not qualifying for Private Residence Relief) and the receipt of carried interest have rates of 18% & 28%.
Dividend Nil Rate
The first £2,000 of dividend income is taxed at 0%, although this does still count towards your Adjusted Net Income and uses up the tax band it falls into. Dividend income above £2,000 is taxed at 7.5% at basic rate, 32.5% at higher and 38.1% at additional.
Personal Savings Allowance
The Personal Savings Allowance (PSA) allows tax free savings income of up to £1,000 depending on the client’s tax position.
Starting Rate for Savings
Starting rate limit (savings income) remains at £5,000 - it’s restricted by non-savings taxable income so that none of the band will be available if that income is above their personal allowance plus the £5,000 starting rate.
Personal Allowance - £12,500 pa tax free
Ok, so we all know that, unless we have Adjusted Net Income in excess of £100,000pa, the first £12,500 of taxable income will fall within the Personal Allowance (PA) and, as such, will be tax free. Keeping your salary within the PA is not an option for many, so most have to accept that earnings during your working lifetime (in excess of the PA) will be taxable. Unfortunately, non-savings income (earnings) in excess of £17,500 also prevents access to the starting rate of tax for savings.
However, many business owners have the potential of setting their own salary, deriving the balance of immediate required income from dividends and taking advantage of employer pension contributions for the balance of available profits. Managing profit extraction can make a considerable difference to the level of tax to be paid both now and in the future
On retirement, the use of a flexi-access drawdown pension allows pension income to be varied, or turned on and off, as individual need requires. Use of this flexibility of income to match the ever-changing PA, when linked to the use of Pension Commencement Lump Sum (see below), offers a very tax efficient and flexible form of income. It goes without saying that the accumulation of a pension fund is extremely tax efficient, with tax-relief on pension contributions and tax-free growth of pension funds.
Recent Finance Acts have tightened down on the amount of contributions that can be made by high earners and those flexibly accessing their pension savings, via the Money Purchase Annual Allowance and the tapered Annual Allowance, but with the appropriate advice substantial contributions can still be achievable. Furthermore, the restrictions of the Lifetime Allowance may impact on the perceived tax efficiency of pensions.
Personal Savings Allowance – up to £1,000pa tax free
We can generate up to £1,000 (basic rate taxpayer) or £500 (higher rate taxpayer) of interest payments without any liability to income tax. This is available to all (except additional rate taxpayers), so will be available to ‘earners’, unlike the starting rate of tax (see below). However, given the current level of interest rates available from high street bank/building society accounts (approx. 0.25%), you’d need £400,000 invested to exceed this allowance (for a basic rate taxpayer), so perhaps alternative investments, such as OIECs (where the fund has more than 60% invested in assets generating interest), are worth considering if this allowance is to be fully utilised.
Starting rate of tax – up to £5,000pa tax free
Those with non-savings (earned) income in excess of £17,500 need not concern themselves with the starting rate of tax. However, if you don’t need to work and derive your income mainly from investments, can vary your income as required or have non-savings income under £17,500, this is for you.
If any of your taxable savings income falls within the first £5,000 of the basic rate band, you will not be liable to pay any tax on it, as the starting rate for savings income is 0%. As well as standard deposit accounts, interest-producing OEICs and chargeable gains on insurance bonds fall into this category.
The starting rate of tax is restricted by non-savings taxable income so that none of the band will be available if that income is above their personal allowance (and blind person’s allowance if claimed) plus the £5,000 starting rate. So the starting rate of tax is more of an advantage for people living off savings or who can vary their non-savings income, rather than people living off earnings.
But remember, those currently working are likely to cease work or retire, so accumulating savings or making an investment that can provide payment of interest, when your non-saving income reduces, could be a sensible proposition.
Dividend nil rate – up to £2,000pa tax free
The first £2,000 of dividend income is taxed at 0% regardless of your current tax position. Based on the FTSE 100 average yield of 3.79% (as at 31/07/18), an investment of approximately £52,770 in OEICs would be required to generate this amount of dividend. So assuming that such an investment suits your risk profile, dividend-producing investments can be a useful tool in boosting your level of tax-free income irrespective of your current tax position.
Capital Gain Tax Annual Allowance – up to £12,000 pa tax free
We know that we can realise gains on investments up to the value of £12,000 pa and not be liable to CGT. This could be from the same investments generating the dividends and interest mentioned above. The capital released with the gain would also boost “income”.
So in essence we are now up to +£32,500 tax free, but it need not stop there
If we include the tax-free Pension Commencement Lump sum from unvested pension funds, the 5% pa tax deferred allowance for investment bonds and the fact that you can make tax-free withdrawals from ISAs, the sky’s the limit.
Pension Commencement Lump Sum (PCLS) - £? pa tax free
The Lifetime Allowance (LTA) is currently £1.055m and expected to increase by CPI each year. 25% of this can usually be drawn tax free. By phasing the PCLS over, say 20 years (i.e. taking 5% of the LTA), and assuming that the LTA increases by 2.5% per annum £13,187.50 could be taken tax free in year one and £336,870 in total could be taken over the 20 years. The taking of a PCLS requires designation of the appropriate funds to a pension income vehicle. Leaving the funds invested via flexi-access drawdown means that clients could subsequently take an income to offset against the Personal Allowance.
Individual Savings Account - £? pa tax free
Although contributions to ISAs don’t enjoy the same tax advantages as pensions, the growth within the wrapper is identical. Any money withdrawn is tax free, without any limitations.
Appropriate planning, use of a multi-wrapper approach to investment, and learning to speak fluent ‘taxation’ (and being able to translate it to a language that a client can understand) can result in considerable tax wins for advisers’ clients.
In an environment where “sustainable income” is one of the financial planners key goals. Tax efficiency equals lower withdrawals equals capital lasting for longer!
In an overall planning scenario, the use of share investment plans, EIS, VCT etc. haven’t been considered. But availability and use of these (if appropriate) could expand the tax efficiency.
The ‘art’ of the adviser is to bring simplicity to the confusion.
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