Setting aside income in the form of savings is important for us all, to provide for the
unexpected or to build up a nest egg that we can enjoy in retirement.
Pensions are one of the most tax efficient forms of saving. Most higher rate taxpayers can contribute £100 to a registered pension fund at a cost of only £60 and investment income and capital gains will accrue within the scheme largely tax free.
An individual is entitled to tax relief on personalcontributions in any given tax year up to the higher of 100% of earned income or £3,600 (gross).
The contributions are paid net of basic rate tax and the pension provider will then recover
that basic rate tax from HMRC. Higher and additional rate relief, if appropriate, can be
claimed from HMRC. Contributions in excess of the individual’s limit can be made into a scheme but the excess will not attract tax relief.
An employer may make contributions to a scheme and a deduction from profits may be
available to the employer.
As these reliefs are generous, there are controls which serve to limit high levels of contribution. These are complex but, put simply, they may give rise to a tax charge if annual contributions exceed £40,000 or if the value of the fund when benefits are taken is greater than a lifetime allowance which, for 2019/20, is £1,055,000. Generally where a taxpayer has adjusted income in excess of £150,000 the annual contribution possible will be restricted from £40,000 by £1 for every £2 for income in excess of the £150,000. The minimum annual allowance available after this restriction is £10,000.
Taxpayers have choice and flexibility when it comes to accessing their personal pension
fund. Options include taking a tax free lump sum of 25% of fund value and purchasing an
annuity with the remaining fund or opting for a more flexible drawdown.
The flexible drawdown rules allow for total freedom to access a pension fund from the age of 55. Access to the fund may be achieved in one of two ways:
- allocation of a pension fund (or part of a pension fund) into a 'flexi-access drawdown account' from which any amount can be taken over whatever period the person decides
- taking a single or series of lump sums from a pension fund (known as an 'uncrystallised funds pension lump sum').
When an allocation of funds into a flexi-access account is made the member typically will take the opportunity of taking a tax free lump sum from the fund.
The person will then decide how much or how little to take from the flexi-access account. Any amounts that are taken will count as taxable income in the year of receipt.
Access to some or all of a pension fund without first allocating to a flexi-access account can be achieved by taking an uncrystallised funds pension lump sum.
The tax effect will be:
- 25% is tax free
- the remainder is taxable as income.
Getting the right advice at the point of retirement is therefore important.
Money Purchase Annual Allowance
The government is alive to the possibility of people taking advantage of the flexibilities by
'recycling' their earned income into pensions and then immediately taking out amounts
from their pension funds. The MPAA sets the maximum amount of tax-efficient contributions an individual can make at £4,000 per annum in certain scenarios.
Tip: Don’t forget to use the dividend and savings allowances. These allowances tax £2,000 of dividends and up to £1,000 of savings income at 0%. See ‘other allowances’ in the ‘A few essentials’ section.
Individual Savings Accounts (ISAs)
ISAs are free of income tax and CGT. There are maximum investment limits which apply
for each tax year but, over several years, large investments can be built up. The overall annual ISA savings limit is £20,000. Investors can choose to invest in a cash ISA, stocks and shares ISA or an Innovative Finance ISA as long as they do not exceed the investment limit.
The Lifetime ISA for adults is available to those under the age of 40. Individuals are able to contribute up to £4,000 per year and receive a 25% bonus from the government. If £4,000 is invested, the investment limit for the other types of ISAs falls to £16,000. Funds, including the government bonus, can be used to buy a first home up to £450,000 at any time from 12months after the first subscription or can be withdrawn from age 60 completely tax-free.
There is also the Help to Buy ISA. Details are in the Property Matters section of the guide.
Other tax efficient investments
The following investments work in varying ways. You should consider your needs in detail before entering into any commitments.
National Savings and Investment (NS&I) Premium bonds
Premium bonds are tax free and you could win £1 million!
However, the annual rate of return is not predictable. The current Premium bonds
investment limit is £50,000. The more you invest the more frequently you are likely to win, the smaller prizes at least. However, there is no guarantee of a steady rate of return.
Single premium insurance bonds
These provide a means of deferring income into a subsequent period when it may be taxed at a lower rate.
Venture Capital Trusts (VCT)
These bodies mainly invest in the shares of unquoted trading companies. VCT are however quoted investments. An investor in the shares of a VCT will be exempt from tax on dividends and on any capital gain arising from disposal of the shares in the VCT. Income tax relief currently at 30% is available on subscriptions for VCT shares, up to £200,000 per tax year, so long as the shares are held for at least five years.
The Enterprise Investment Scheme (EIS)
Income tax relief at 30% is available on new equity investment (in qualifying unquoted
trading companies) of up to £1 million. A higher limit of £2 million may apply to investments in ‘knowledge intensive companies’. A CGT exemption may be given on sales of EIS sharesheld for at least three years. If the gain on the sale of any chargeable asset (eg quoted shares, second homes, etc) is reinvested in EIS shares, the gain on the disposal can be deferred.
Seed Enterprise Investment Scheme (SEIS)
The tax breaks for SEIS investors are:
- income tax relief at 50% in respect of qualifying SEIS shares up to an annual maximum investment (in all SEIS companies) of £100,000
- a CGT exemption where SEIS shares are sold more than three years after they are issued (as for EIS)
- a further CGT exemption of 50% where an individual makes a capital gain and reinvests the gain in qualifying SEIS shares.
For more information, please don't hesitate to contact us.