Three ways to get ‘ahead of the curve’ in the new tax year
By now, most of us are well aware of the ‘tax year end’ rush, where many attempt to squeeze every penny into pensions and ISAs in the final few days before the deadline. We’ve all heard stories too of friends and family missing the deadline by a day or two and missing out on potentially thousands in tax relief (and subsequent missed growth).
Of course, there will always be people who wait until the last moment, but we believe smart financial planning looks ahead and plans accordingly. Easing the burden and minimising stress, while maximising growth and tax efficiency in your portfolio.
So… here is our ‘tax year start checklist’ - three things you should think about and organise now, and not in 11 months’ time (make sure you scroll to the end for some bonus tips too)!
1: Funding your ISA and pension early
Perhaps one of the easiest yet most important steps you can take is to fund your ISA and pension early or regularly, rather than in one lump sum at the end of the tax year. When you think about it, by paying into them now you are allowing those monies to grow in a tax free environment for 11 months longer, which is quite a significant length of time!
If you are a client of CAM already you can ask your Investment Manager to automatically fund your ISA from your general account at their discretion. This not only takes something off your plate, but also allows us to fund your ISA at the most optimal time.
Alternatively, setting up regular monthly payments into your ISA or pension (whether these are with us or otherwise) could be another way of benefitting from the tax exemption earlier without committing a lump sum up front. It doesn't have to be all-or-nothing, and the sooner you can get your money growing tax-free, the better. Not only this, but by investing regularly you will also benefit from pound-cost averaging, which can help by largely mitigating the risk of poor market timing!
2: Income tax planning
This is an area not often discussed, but it can have a material impact on your life if not considered properly. This is true whether you are earning a salary or drawing down on your pension, meaning there are planning opportunities to seize no matter which stage of life you are in.
There are countless methods by which you can manage your income to maximise efficiency. For brevity, in this article we shall focus on the two little-known ‘secret tax brackets’ which catch many of us out, sometimes without us even realising it!
For incomes above £100,000
The first secret tax bracket to discuss is the 60% rate on income between £100,000 and £125,140. Now, this is not a defined tax bracket but rather is an ‘effective rate of tax’ since we lose £1 of our Personal Allowance for every £2 earned over £100,000. This means you will pay an extra 20p on the pound in tax from losing this allowance on top of the usual higher-rate tax band of 40%, up until your entire £12,570 personal allowance has been stripped away!
For income above £50,000
This only applies to anyone with children, or who are planning to have children in the near future. Child Benefit is a universal benefit for anyone in the UK with children under age 18, but for households with a high earner (£50,000+) this starts to get clawed back through an additional tax. The rate of the clawback is a tax of 1% of your total Child Benefit for every £100 of income over £50,000, and is charged to the highest earner in the household regardless of who actually receives the benefit. So, this effectively means if you receive Child Benefit and your partner receives, for example, £55,000 in income then there will be an additional tax charge to your partner equal to 50% of the benefit you received (£55,000 - £50,000 = £5,000 in the bracket. £5,000 x 1% = 50% charge).
Consequently, the effective tax rate on income between £50k and £60k can be significantly higher than the higher-rate band (40%), depending on your income and the number of children you have. This can get quite complicated to calculate, so if you are unsure of whether this affects you then be sure to ask your financial adviser.
So how can you change this? There are three main ways to prevent yourself falling into these secret tax brackets:
A. Reduce your income
This is the simplest answer and perhaps only applies to a niche group – those of you who are drawing down on assets in excess of your needs. This might be a good opportunity to review the income you are drawing and scale this back if this is feasible, especially if your expenditure has reduced over the years. Simply reducing your income to £50,000 or £100,000 respectively may save you a significant amount of tax without impacting on your standard of living.
B. Make a pension contribution
Conversely, this will predominantly apply to those currently in work. Making a contribution to your pension will bring your “net adjusted income” down, meaning you could bring your total income received below the threshold figures of £50,000 or £100,000. As consequence you will not be subject to the additional tax and in-fact will receive tax relief on your contribution! You can also tie this in with point 1 and plan your pension contributions at the start of the tax year, with monthly pension contributions being especially effective!
C. Re-arrange your assets
If you have assets producing income in the background, whether this be rental income or dividends from shares, consider reviewing these arrangements. Moving these assets into the name of the partner with the lower income could be appropriate and may put you in a better overall tax position when viewed jointly. Alternatively, consider whether these assets are necessary and whether assets focusing on capital growth might be more suited to your needs.
3: Gifting
Whether you are saving regularly for your children, helping someone with a house deposit, or making small gifts to friends and family, this is a good time to start planning ahead. First and foremost, we are only able to gift assets while we are alive and so sooner is almost always better when it comes to passing on assets. We don’t know when we’re going to go, so it is best to make your gifts before it is too late, but importantly this will also begin the 7-year clock for inheritance tax (IHT) that much sooner too.
If you are making a gift into a Junior ISA or a straight gift to friends or family, then you may wish to maximise their potential for growth by making the gift earlier. This is a personal choice, as you could delay the gift to benefit from the growth yourself, however by making the gift in the first place it is assumed you wish for the recipient to benefit as much as possible from the monies. By making the gift early this allows for a longer investment period and, hopefully, greater benefit to them.
That said, gifting is never this straightforward and the timing is often based on emotional or non-tangible reasons. We understand that these are highly personal decisions, and we are more than happy to discuss gifting and inheritance tax with you if you have any particular queries. The main takeaway from this point is: if you have decided to gift assets away, but have not pinned down the specifics, now is a good time to make those plans and to act on them.
And here are some bonus tips for making the most of your tax year:
1. Claim your capital losses from the past four tax years and tell us.
You can make a claim for capital losses incurred in any of the past four tax years; you cannot go back any further. Take some time to claim these losses through HMRC and make sure to tell us how much you have claimed. We can then adjust our strategy for your portfolio accordingly and begin to offset future gains against the loss, thereby minimising your tax bill.
2. Make a budget
Making a budget can have two main impacts on your finances: first it allows you to see how much you are actually saving/spending and puts you in charge of this figure going forwards. The second benefit is it can act as a prompt by highlighting any excess spending, such as recurring direct debits for old subscriptions, or that rising broadband bill in desperate need of a switch.
If you are a client of CAM then ask us for our expenses breakdown sheet which should largely simplify the process for you (and do let us know how you get on!).
3. Review your existing investments, if you haven’t done so for a while
With auto-enrolment in full swing it seems even easier to collect a dozen different pensions over the years to add to all the endowments, ISAs and life policies we bought, put in a cupboard somewhere, and forget about for months on end. If this is you, then now is a good time to review these and make sure you’re putting your money to better use. If you have a financial adviser then they should be happy to look through any old paperwork you find to make sense of it all for you. If you don’t have an adviser then one of the team here at CAM would be pleased to chat with you about what you’ve dug up!
This article was prepared by Connor Read, a paraplanner at CAM. We always appreciate your feedback. If you have enjoyed this article or have any specific topics you would like to see addressed in future newsletters, please email us at FPTeam@city-asset.co.uk.