In our latest blog, PM+M financial planning director James McIntyre highlights the various personal allowances which can be utilised to get ahead in your financial planning.
Annual Allowance – Pensions
The standard annual allowance for pensions is £40,000, but this can decrease if benefits have been accessed, or if an individual is, or has been, a high earner.
Consider taking advantage of carry forward allowances – you could potentially utilise any annual allowances that haven’t been used during the previous three tax years. In theory, this means that a potential pension contribution of up to £160,000 could be utilised.
It is vital that you take advice to ensure that you don’t exceed your allowance. There is a pitfall in the form of “the tapered annual allowance”, whereby at certain income thresholds, your pension contribution allowance tapers down to as little as £4,000 for the current and previous three tax years.
Pensions also benefit from tax free growth; they normally don’t form part of your estate for inheritance tax planning and there might be preferential death benefits – all of which are great advantages.
However, you should be wary of the relevant earnings pitfall. When a personal pension contribution is made, you must have the relevant earnings to support this (unless the employer is paying). Relevant earnings are the earnings available to base a pension contribution on, generally including all earned income, except, pension income, dividends and most rental income.
The child benefit and personal allowance tax traps kick in at an adjusted net income over £50,000 and £100,000 respectively. Income over £50,000 results in a reduction/loss of child benefit, and income over £100,000 results in a reduction/loss of personal allowance. An advantage of increasing your pension contributions is that your adjusted net income is reduced, thus, returning higher than marginal rate tax relief. Put simply – we may be able to ensure that your child benefit and personal allowance remains intact by making a pension contribution.
Most people have £12,500 of tax free income as an annual allowance which cannot be carried forward. If there is any personal allowance remaining that is not necessarily going to be available in future tax years, then any taxable withdrawals already planned may be best brought forward. For example, there might be the option to access your pension assets in order to utilise your personal allowance (assuming you have reached the minimum pension age). You may even be able to reinvest the proceeds into an ISA which benefits from tax free growth, or the withdrawal may be used to make the most of your annual gifting allowance for inheritance tax purposes. You may even just want the extra cash!
Inheritance Tax (IHT) – Annual gifting allowance
An individual has an annual exemption for lifetime transfers of £3,000 per tax year. After making use of your current year’s exemption, you can also carry forward any unused amounts from the previous tax year.
For larger estates, £3,000 is not going to make a serious dent in your IHT liability, so some larger lump sum gifts may be the better option. The cumulative effect is advantageous here, as each use potentially saves £1,200 in IHT. Therefore, over ten years, it’s the difference between giving your family £30,000 or £18,000 (or double those number if it’s joint planning with a couple). The ability to carry forward the previous years unused allowance could allow a couple to give away £12,000; a sum which could be carrying a £4,800 tax liability, had it otherwise been liable to IHT.
You can cleverly enhance your tax advantages by using someone else’s pension. Assuming they have earnings to support it, the £3,000 could be paid as a third-party pension contribution. The government would top this up to £3,750, due to the basic rate relief at source. If that person is a higher rate taxpayer a further £750 tax reduction could be claimed.
Capital Gains Tax (CGT) – annual exemption
Each year, you can crystallise gains up to the annual exempt amount with no CGT to pay- this year it is £12,300. It should be remembered that any gains before the exempt amount are offset where losses have been realised in the same tax year.
Conversely, this could be a good time to consolidate losses if there are no gains crystallised in the year as the full amount will be available to carry forward and offset against gains in future years. Losses could potentially be recovered through the tax relief received by reinvestment in a pension.
The current CGT uplift on death means that you will gain effectively, so there’s no need to worry about using your annual exempt amount where assets are subject to CGT on disposal.
It may also be worth utilising your annual gifting and CGT allowances in tandem, to reap double the benefits!
Tax free growth and tax free withdrawals mean utilising an ISA allowance is the first port of call for many who have new money to invest. Where new money is not available, it would seem sensible to consider any other less tax efficient investments and whether they could be encashed to generate the funds to allow the use of the ISA allowance. Clearly, any tax impact or penalties on encashment would form part of the overall analysis.
Be sure to make use of any benefits first so you don’t miss out on some valuable allowances.
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