As night follows day, come the end of March and beginning of April each year, you will see many investors busy reorganising their investments, looking to reduce their tax liabilities. While you can take numerous actions in isolation, in many ways, it is the long term cumulative impact that is most important. We will now look at ways to protect your investments and maximise income.
Maximising your pension assets
Regarding pension fund assets, there are tax benefits for investments and contributions. As you review the potential attractions, it is essential to note the short-term tax benefits and the long-term nature of these investment vehicles.
Increase your tax-free contributions
Currently, you will receive annual tax relief on pension contributions on the higher of £3600 or 100% of your UK taxable earnings, up to a maximum of £60,000. In addition, as long as you were a pension plan member at the time, there is also the potential to utilise any unused pension contribution allowances from the previous three tax years.
Salary sacrifice
As we saw recently, governments often use a strategy known as “fiscal drag” to increase tax income while not increasing tax rates. Typically, income tax bands rise in line with inflation, thereby maintaining relative income tax liabilities for individuals. Where wages rise in line with inflation, but tax bands remain static, millions more people will see increased tax payments. However, there may be an opportunity to use salary sacrifice.
If someone has received a significant salary increase and faces an increased income tax liability, they may consider a salary sacrifice arrangement with their employer. This would involve giving up part of their gross salary increase in exchange for a higher employer pension contribution. Thus, while reducing the employee’s income tax liability, this would also increase their pension pot.
No capital gains tax/income tax
Assets held within pension funds are free of income and capital gains tax. So, you benefit from the tax-free umbrella, and individual pension contributions also attract tax relief. When your pension funds are accessible, aside from your tax-free lump sum, any withdrawals will be added to your income for that tax year and charged at the appropriate tax rate.
Shielding your investments from taxation
Since the 1980s, when private individuals became more interested in direct stock market investment, we have seen numerous tax-efficient investment vehicles. Personal Equity Plans (PEPs) first emerged in 1986, to be replaced by ISAs in 1999. While reviewing your investments, it is important to consider any tax-free umbrellas.
Tax-free umbrella
The benefits of an ISA tax-free umbrella, where investments are free of income and capital gains tax, will become more evident in the future. For example, the UK government reduced the individual capital gains tax allowance from £12,300 in the 2022/23 tax year to £6000 in the 2023/24 tax year and £3000 from the 6th of April 2024. The greater the share of your investments sheltered under tax-efficient umbrellas, the less exposure to capital gains and income tax. Where applicable, tax-free umbrellas, such as ISAs, should be part of your long-term investment strategy.
Utilise your ISA allowance
The ISA allowance for the tax year 2024/25 is set at £20,000 per person. The limit for a Junior ISA, considered a valuable form of saving for children, is currently £9000 per annum. While these are the maximum contributions you can make to each ISA per annum, there is no limit on the value of an ISA. For example, having utilised previous allowances, some ISAs are currently valued in the hundreds of thousands of pounds (some even over £1m). Unlike some allowances, which can be carried forward, this is not the case for ISAs. It is simply a case of “use it or lose it” within that tax year.
Conclusion
Various annual allowances help to maximise pension funds, minimise tax liabilities and utilise tax-free umbrellas. In isolation, some of these allowances may seem relatively minor. However, the cumulative annual impact of these allowances replicated year after year can hugely benefit your long-term wealth and income in retirement.
It is essential to take professional financial advice on the correct choices for your situation, but dismissing these allowances as irrelevant may prove costly in the long term. Please contact us, and we can discuss the benefits in more detail.