While “the clock is ticking” is a phrase that has been used a lot over the last year with the Brexit deadline approaching, Bestinvest's managing director Jason Hollands says there is an equally important date looming on 5 April for using up precious tax allowances.
And, unlike the 29 March date when the UK is due to leave the EU, which parliament may vote to delay next week, the end of the 2018/19 tax year is immovable.
With limited time to act, Hollands lays out five key priorities to consider.
1. ISA allowance
Hollands (pictured) said ISAs should sit at the cornerstone of your longer-term savings strategy, as they offer an extensive choice in the types of investments they can hold (from cash to stocks & shares), tax-efficiency and complete flexibility – allowing you to access the proceeds at any point in time
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“This makes them suitable for a wide range of purposes, including paying off a mortgage or supplementing a pension,” he added.
“Returns within ISAs are ring-fenced from the taxman and the value of this, even if not immediate, builds over time as the investments grow.”
With the allowance now £20,000 per adult each year, Hollands said most families have the scope to build a completely tax-free portfolio of savings and investments using ISAs.
The only problem is these wrappers are offered on a “use it or lose it basis”, so if not secured by midnight on 5 April, the 2018/19 ISA allowance will be lost for good.
“One of the reasons people might allow their 2018/19 ISA allowance to slip between their fingers is that they are unsure whether it is a good time to invest or don’t know where to invest,” Hollands added.
“Sentiment has certainly been dented by current UK political uncertainties and the volatility seen in the markets at the end of last year. However, while this is perhaps understandable, in reality it is not the choice investors face in the run-up to the end of the tax year.”
It is worth remembering the 5 April deadline is only the point at which an ISA account must be funded, not when any cash should be invested in the markets.
So, if you are in any doubt as to where or when to invest, Hollands said you should put your money in now and decide later as cash can be withdrawn at any point.
2. “Bed and ISA”
Hollands said anyone who does not have cash to invest, but who owns shares or funds held outside ISAs, should seriously consider using these to fund an ISA subscription, a process he refers to as “Bed and ISA”.
“This involves selling the existing investment to generate cash to fund an ISA contribution, which could then be used to either repurchase the previous investment or an alternative but with future returns being sheltered from taxation,” he explained.
If you are going to take this step, it is important to make sure any gains crystallised on the sale of the existing investments do not unnecessarily trigger a capital gains tax liability (the allowance this year is £11,700).
You also need to be aware that the “Bed and ISA process” can take more than a week if you leave it up to the platform to process.
3. Maximise pension contributions
While pension assets cannot be accessed until the age of 55, these wrappers have become a lot more flexible since reforms were introduced in 2015 and Hollands said they remain unrivalled in their tax advantages.
“This is because savers receive tax relief on their pension contributions at their marginal income tax band, with contributions topped up by basic-rate tax and those on the higher and additional rates of income tax also receiving a deduction on their income tax bill,” he explained.
“In effect this means a £10,000 gross pension contribution will cost a basic-rate tax-payer an outlay of £8,000, while a higher rate-taxpayer will also get £2,000 lopped off their income tax bill, meaning the net cost of a £10,000 investment for them is achieved for just £6,000.”
Source: Standard Life
For most people, the annual gross pension allowance is up to £40,000 – twice that of an ISA. Making use of pensions is particularly attractive for those in the higher and additional rates of tax.
However, this should not be taken for granted: Hollands said the Treasury has been eying the cost of pension tax reliefs for some time and chancellor Philip Hammond described them last year as “eye-wateringly expensive”.
“These currently generous reliefs may not be available for ever and might be a soft target for a future government looking to raise tax on higher earners,” he added.
Unlike ISAs, unused pension allowances from previous years can be utilised through a mechanism called ‘Carry Forward’. Under Carry Forward rules, anyone who has first maximised the current year pension allowance can then look back over the three previous years and mop-up any unused allowances starting with the earliest year.
Carry Forward allowances
Source: Bestinvest
For high earners and those needing to play catch-up with pension savings, perhaps because their financial circumstances have improved, Hollands said maximising pensions including using Carry Forward should be one of their top-priorities.
Pensions are also attractive from an inheritance tax planning perspective as, providing the plan is a modern, money purchase scheme, any remaining assets remaining in the wrapper at death will not form part of an estate for the purpose of assessing inheritance tax. If you die before aged 75, your named beneficiaries will receive the pension free of tax and if you are over 75, they will pay tax on it at their own tax rate, as and when they chose to access it.
4. Utilise your capital gains allowance
One of the most overlooked allowances is the annual capital gains exemption. This tax year, you can crystallise gains made on the sale of an asset (outside of ISAs and pensions) of up to £11,700 per person without being subject to capital gains tax
“Using the allowance to migrate investments into ISAs or pensions is a shrewd move and married couples or civil partners have the option of making use of two sets of allowances, by first switching investments held by one partner to the other, before selling,” Hollands explained.
“This is because inter-spousal transfers do not trigger a tax event. Doing this is very easy and should not involve any cost.”
Regular use of capital gains allowances can make sense even where the proceeds are not then being funnelled into ISAs or pensions. Generating tax-free lump sums can help finance retirement living costs alongside pension income while also reducing a potential inheritance tax liability. But if gains are taken and then reinvested again, this can help reduce a much bigger capital gains tax liability from building up over time.
5. Lifetime gifting
Hollands said that rising property and asset prices mean more and more people are “sleep-walking” into the trap of inheritance tax (IHT) on their assets, which last year generated a record £5.2bn for the Treasury.
“Yet in truth, IHT is a voluntary tax that can be reduced or avoided altogether with careful forward planning,” he said. “However, the options are not well understood and can be complicated.”
“One of the simplest options to eliminate a future IHT liability is to give money away that you won't need yourself when you are alive and well to the people you care about,” he said. “Everyone has an annual gifting allowance of £3,000 and can also make small gifts of up to £250 per person.
Inheritance tax on gifts
Source: GOV.UK
“Regular gifts of out of excess income, rather than capital, can also be made providing they don’t impact your lifestyle. But importantly, any gift will become potentially exempt from counting towards an estate for inheritance tax purposes, providing you live another seven years after making it.”