The biggest talking point in our industry this week has been Wednesday’s budget. Below I have provided a summary of areas which could affect you, some ideas for organising your assets in the most tax efficient way and a reminder of how the main personal allowances work.
THE BUDGET BACKGROUND
It is less than a year since Rishi Sunak presented his first Budget, after having been in the role of Chancellor for less than a month. His despatch box première featured an allocation of £12bn towards mitigating the impact of the Covid-19. Ironically, on the same day as Mr Sunak revealed that boost to spending, the World Health Organisation declared the outbreak a pandemic. Total expenditure on dealing with the pandemic is now estimated to be around £300bn.
The March 2020 Budget was what should have emerged in the Autumn of the previous year, before being deferred because of the General Election. The March 2021 Budget is the result of a similar delay. Last September the Chancellor decided that the uncertainties created by the pandemic meant it wisest that he waited until Spring 2021 to present the Budget. Since then, Mr Sunak has been kept busy announcing extensions to the various Covid-19 support schemes introduced in 2020. Whether the Chancellor feels the economic outlook today is much clearer than six months ago is a moot point.
One financial aspect which has been painfully clear for some time is that the government’s finances have been fundamentally changed by the pandemic. A year ago, the Office for Budget Responsibility (OBR) forecast that the government would borrow around £55bn in 2020/21. Twelve months later its estimate has risen to £400bn. The coming year, 2021/22, should see borrowing more than halve according to the OBR, but the deficit is still projected to be running at over £160bn – more than three times the figure of just two years ago.
Dealing with this level of borrowing is probably not what Mr Sunak signed up for when he moved into 11 Downing Street. He now has to deal with total government debt of about £2,100bn, equal to the UK economic output for the year. The last time debt was as high was in the early 1960s, when the UK was still in the business of paying down the bills incurred in the World War II.
Despite the lake of red ink, Mr Sunak was never going to introduce significant tax increases in this Budget. For a start, nearly all economists, regardless of political hue, were saying that economic recovery was the priority and sorting out the debt could wait. Secondly, Mr Sunak’s boss, Boris Johnson, cannot even bring himself to mention the A-word (austerity) which would ruin his ‘levelling up’ agenda. As a result the Budget was one of tax pain largely deferred.
The proposals which may be of most interest to you were:
- The addition of £70 to the personal allowance and £200 increase in the basic rate band, in line with indexation requirements. However, after 2021/22, the personal allowance and higher rate threshold (outside Scotland) will be frozen for four tax years.
- The inheritance tax nil rate band, the pensions lifetime allowance and the capital gains tax annual exemption will all be frozen at their current levels for the next five tax years.
- For companies with profits of over £250,000, in April 2023 the rate of corporation tax will jump by 6% to 25%. A new smaller companies’ rate of 19% for companies with profits of up to £50,000 will be introduced at the same time.
- The temporary £500,000 0% band for stamp duty land tax will continue to apply for residential property purchases up to 30 June 2021. The band will then be halved for the following three months before reverting to its original £125,000 level from 1 October.
- The coronavirus job retention scheme (CJRS – furlough scheme) and the self-employed income support scheme will be extended to September, albeit with reductions in the final three months of their life.
10 QUICK TAX TIPS
1. Don’t waste your (or your partner’s) £12,570 personal allowance in 2021/22.
2. Don’t forget the personal savings allowance, reducing tax on interest earned.
3. Don’t ignore the dividend allowance, eliminating tax on £2,000 of dividends.
4. ISAs should normally be your first port of call for investments and then deposits.
5. Make use of tax relief which can be obtained with a contribution into your pension.
6. Tax on capital gains is usually lower and paid later than tax on investment income.
7. Trusts can save inheritance tax, but suffer the highest rates of CGT and income tax.
8. File your tax return on time to avoid penalties and the taxman’s attention.
9. If you are entitled to a company car, going hybrid or electric could slash your tax bill.
10. Don’t assume HMRC won’t know: automatic information exchange is now widespread.
Refresher on how some of the main personal tax allowances can work for you:
THE PERSONAL ALLOWANCE
The personal allowance was given a standard inflation-linked increase to £12,570 for 2021/22. The announcement of the minimal uplift was made in November, hidden on page 22 of the Spending Review. For 2022/23 to 2025/26 inclusive the allowance will then be frozen. Many people do not use the current personal allowance to the full and in 2021/22 there will be a gap of just over £3,000 between the allowance and the starting point for National Insurance contributions (£9,568). At the other end of the income scale, some taxpayers will have no personal allowance in 2021/22 (or future tax years up to 2025/26) because their income exceeds £125,140, at which point their allowance is tapered to nil.
If you or your partner do not use the personal allowance to the full, you could be paying more tax than necessary. There are several ways to make sure you maximise use of your allowances:
- Choose the right investments: some investments do not allow you to reclaim tax paid while others are designed to give capital gain, not income.
- Couples should consider rebalancing investments so that each has enough income to cover their personal allowance.
- Make sure that in retirement you (and your partner) each have enough pension income. On its own, state pension provision is not enough, be it the new state pension (up to £179.60 a week in 2021/22) or the old state pension of £137.60 a week (if you reached State Pension Age before 6 April 2016).
- If one of you pays tax at no more than basic rate and the other is a non-taxpayer, check whether it is worth claiming the transferable married allowance (£1,250 in 2020/21 and £1,260 in 2021/22).
THE PERSONAL SAVINGS ALLOWANCE
The personal savings allowance (PSA) first appeared in April 2016 and has been unchanged since then. Broadly speaking, if you are a:
- basic rate taxpayer, the first £1,000 of savings income you earn is untaxed;
- higher rate taxpayer, the first £500 of savings income you earn is untaxed;
- additional rate taxpayer, you do not receive any personal savings allowance.
‘Savings income’ in this instance is primarily interest, but also includes gains made on investment bonds, including offshore bonds. Although called an allowance, the reality is that the PSA is a nil rate tax band, so it is not quite as generous as it seems. The PSA means that banks, building societies, National Savings & Investments and UK-based fixed interest collective funds all pay interest without any tax deducted, but they do report payments to HMRC. Thus, if your interest income exceeds your PSA – no mean achievement at current interest rates – you could have tax to pay. Be warned that if you do not tell HMRC, it will have the data to tell you.
If you and your spouse/civil partner receive substantial interest income, it is worth checking that you both maximise the benefit of the PSA. However, at today’s ultra-low interest rates you might also want to consider whether you could earn a higher income by choosing non-deposit based investments.
THE DIVIDEND ALLOWANCE
The dividend allowance also started life in April 2016, originally at a level of £5,000 before it was reduced to the current £2,000. The allowance means that in 2021/22 the first £2,000 of dividends you receive are not subject to any tax in your hands, regardless of your marginal income tax rate. Once the £2,000 allowance is exceeded, there is a tax charge of 7.5% (for basic rate taxpayers), 32.5% (for higher rate taxpayers) and 38.1% (for additional rate taxpayers). Like the PSA, the dividend allowance is really a nil rate band, so up to £2,000 of dividends do not disappear from your tax calculations, even though they are taxed at 0%.
The pandemic prompted many companies to reduce or stop paying dividends in 2020. As a result, the historic yield on UK shares is now around 3.05% which means in theory a portfolio worth more than about £66,000 could attract additional tax on dividend income, even for a basic rate taxpayer. In practice, that threshold portfolio size could prove to be smaller in 2021 as dividend payments should rise over the next 12 months.
THE STARTING RATE BAND
The starting rate band for savings income was launched at £5,000 in 2016/17 and a tax rate of 0%, and will remain on that basis for 2021/22. Sadly, most people are not able to take advantage of the starting rate band: if your earnings and/or pension income exceed £17,570 in 2021/22, then that probably includes you. However, if you (or your partner) do qualify, you will need to ensure you have the right type of investment income to pay 0% tax.
Planning Point: If you don’t anticipate using all your personal allowance or PSA in 2020/21 think about creating more income by closing deposit accounts before 6 April and crystallising the interest in this tax year. But beware of early closure penalties and shutting down accounts with better interest rates than are available now!
For next tax year, think about who should own what in terms of investments and savings. The savings and dividend allowances mean it is not simply a question of loading as much as possible on the lower rate taxpayer of a couple. In theory, you will each be able to receive an income of up to £20,570 tax free in 2021/22, but only if you have the right mix of earnings, savings income and dividends.
CAPITAL GAINS TAX (CGT)
Capital gains tax was a tax which attracted the Chancellor’s attention last year. He asked the Office of Tax Simplification (OTS) to review the operation of the tax. The OTS’s first report was published in November, but the Chancellor made no mention of it in his Budget, deciding only to freeze the annual exempt amount at £12,300 for the next five tax years
Gains are currently taxed as the top slice of income, but the rates are lower than those that apply to income not covered by allowances. Gains are generally taxable at 10% to the extent they fall in the basic rate band (£37,500 in 2020/21 and £37,700 in 2021/22) and 20% if they fall into the higher or additional rate bands. An additional 8% applies to gains on residential property and carried interest. For 2021/22 through to 2025/26, the capital gains tax annual exempt amount will be, as it is now, £12,300.
The current tax rates and annual exemption mean that if you can arrange for your investment returns to be delivered in the form of capital gains rather than income, you will often pay no tax on your profits. While investment decisions should never be made on tax considerations alone, once the £2,000 level of the dividend allowance is exhausted, favouring capital gains over income when setting your investment goals can be a sensible approach.
INDIVIDUAL SAVINGS ACCOUNTS (ISAs)
The annual ISA investment limit for 2021/22 will remain at £20,000. There will be no change in the £4,000 limit for the Lifetime ISA (LISA), which was launched in April 2017 to encourage savings by the under-40s. The limit for the Junior ISA (JISA) was also unaltered, but it was more than doubled to £9,000 last year, as was the Child Trust Fund (CTF) limit.
ISAs have long been one of the simplest ways to save tax, with nothing to report or claim on your tax return. The arrival of the LISA complicated matters, as it sits somewhere between the traditional ISA and a pension plan. If you are thinking of a LISA instead of either of these, you would be well advised to seek advice before taking any action.
Over time substantial sums can build up in ISAs: if you had maximised your ISA investment since they first became available in April 1999, you would by now have placed over £240,000 largely out of reach of UK taxes.
We are fast approaching the end of the tax year, so if you would like to use your ISA allowance in full or partially, please let me know as a matter of urgency.
The amount that can be contributed each year, the annual allowance, while still receiving valuable tax relief, is based on your earnings for the year and is capped at £40,000, unless the tapered annual allowance referred to below applies. You may also be able to carry forward past years allowances. Employer contributions can also be made from your company, if applicable, which can be treated as an allowable business expense, and offset against your company’s corporation tax bill.
The end of the tax year is now only one month away, so if you wish to take advantage of your annual allowance to increase your retirement provision, please get in touch with me urgently.
For 2020/21 there was a £90,000 increase to both of the annual allowance tapering trigger points, taking them to £200,000 (threshold income) and £240,000 (adjusted income). However, there was a sting in the tail for people with very high incomes: the minimum tapered annual allowance dropped from £10,000 to £4,000 (at an adjusted income of £312,000 or more).
- State pension age (SPA) increases have stopped for the time being at age 66. An increase to 67 is due between April 2026 and March 2028. The rise to 68 is scheduled between April 2037 and March 2039, although the necessary legislation has been deferred and the dates could change due to a slowing rate of life expectancy increases. By 2050 – so if you are under 40 now – you could be facing a SPA of 69.
- The government has confirmed that from 6 April 2028 the normal minimum age at which you can draw benefits from a private pension will rise from 55 to 57.
- The lifetime allowance was due to be increased in line with inflation, but instead has been frozen at its current £1,073,100 until 6 April 2026. By coincidence, that date will mark the 20th anniversary of the lifetime allowance introduction – at a level of £1,500,000.
PAY LATER, NOT NOW?
For higher and additional rate taxpayers, there can be a case for considering the options for tax deferral, once the decision on which sector to invest in has been made. The potential advantages and disadvantages of tax deferral include:
- What would be going to the Treasury instead remains invested, enhancing potential returns.
- There is the possibility that tax rates will be lower when the investment is realised. The opposite risk is that the 50% top tax rate could reappear following a change of government, although that is now probably over three years away. However, your marginal tax rate could rise anyway because of the impact of tax bands and allowances frozen until 2026.
- Some tax liability might disappear completely. Under current rules there is generally no capital gains tax on death, although several voices, including the OTS, have suggested this relief should be withdrawn.
- The investor may change their country of residence, giving rise to a lower tax rate or possible tax savings during the period of transition between the old and new homes.
There is a variety of tax-deferral options available but, as ever, advice is needed to help navigate away from any potential pitfalls.
NIL RATE BAND
The nil rate band reached its current level of £325,000 in April 2009. From 6 April 2021 the 12-year freeze had been due to come to an end. However, there was no thaw and the nil rate band will now stay at £325,000 until April 2026. Had the nil rate band been increased in line with CPI inflation, it would be about £415,000 – £90,000 higher – in 2021/22.
To date a dozen years of frozen nil rate bands have dragged more estates into the IHT net and more will be added over the next five years. If your estate is are already potentially liable to IHT, the freeze could mean it will suffer more tax in the future as inflation takes it toll. Since April 2009, average UK house prices are up by about 54% , according to Nationwide, and UK share prices have risen by 80% (March 2009 marked their low point in the wake of the financial crisis).
REDUCED NIL RATE BAND
The residence nil rate band (RNRB) came into effect on 6 April 2017 with an initial figure of £100,000. For 2021/22 through to 2025/26 inclusive, the RNRB will remain at £175,000. The threshold above which the RNRB is subject to a 50% taper reduction will also be frozen for five years at £2,000,000, meaning it will be lost altogether for estates valued at £2,350,000 or more (£2,700,000 on second death for couples where the RNRB is unused on first death). While the RNRB does help to ease the burden of IHT for many estates, it is by no means a panacea: after a pandemic-induced dip, in the long term the government’s IHT tax take is expected to keep rising according to the OBR projections.
IHT YEARLY EXEMPTIONS
The continued freeze of the nil rate band makes the yearly IHT exemptions all the more important:
- The £3,000 annual exemption. Any unused part of this exemption can be carried forward one tax year, but it must then be used after the £3,000 exemption for that year. So, for example, if you made a gift of £1,000 covered by the annual exemption in 2019/20, you can make gifts totalling £5,000 covered by the annual exemption in 2020/21 by 5 April 2021.
- The £250 small gifts exemption. You can make as many outright gifts of up to £250 per individual per tax year as you wish free of IHT, provided that the recipient does not also receive any part of your £3,000 annual exempt amount.
- The normal expenditure exemption. Any gift that you make is exempt from IHT if:
– it forms part of your normal expenditure; and
– taking one year with another it is made out of income; and
– it leaves you with sufficient income to maintain your usual standard of living.
In July 2019, the Office of Tax Simplification (OTS) made a range of proposals to simplify some of the complexities of IHT. It had been expected (and rumoured) that some of these would be taken up in the 2021 Budget, but instead the Chancellor made no mention of the tax. His silence on this occasion may be for the same Covid-19 focus as last year. However, IHT reform may still be on the agenda, perhaps in the Autumn Budget. With calls for wealth tax growing, restructuring IHT is one way to address the same issue without creating a new tax regime.
As is often the case with ‘simplification’, the OTS proposals would have created winners as well as losers. Given that there has now been what looks like a delay, if IHT is a concern to you, then it would be wise to seek advice on which category you might fall into.
Finally, please find below a link to a short YouTube video highlighting the changes by our partner accountancy firm, McPhersons:
If you wish for your financial adviser to assist in any aspect of your financial planning or to discuss the tax efficiency of your investments and assets please do not hesitate to get in touch.
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