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The 5th April deadline for the 2020-21 tax year has now passed. For those who took time to get the most out of their allowances beforehand, this could have saved you a lot of money. If this did not make your “to-do” list, then below we outline some great reasons to consider adding it as a priority in the new 2021-22 tax year. After all, doing so could result in 100s – maybe £1000s – put back into your pocket.
Below, we also offer how to make the most of your allowances so they are not lost before the next April deadline. If you’d like to find out more or discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
Why your ISA matters
Whilst we should all pay our fair dues, none of us should pay more than necessary due to poor planning. UK taxes have the potential to significantly reduce your savings and investments. For instance, consider the following tax brackets in 2021-22:
- Capital gains tax. This tax applies to an asset you sell for a profit, such as shares. Here, a Basic Rate taxpayer might pay 10% on gains or 18% on residential property which is sold. For people on the Higher Rate, the rates are 20% or 28% respectively.
- Dividend tax. This is tax levied on dividend payouts from companies which you hold shares in. The rate is 7.5% for Basic Rate taxpayers, 32.5% for the Higher Rate and 38.1% for the Additional Rate.
- Tax on interest. You also pay tax on any savings interest earned within a regular savings account, depending on your income.
These rates do not take into account any allowances (which we will cover shortly). For the sake of showing how these taxes could erode your savings and investments, however, consider the following example. You earn £75,000 per year and take £3,000 per year in dividend income in a single financial year, leading to £1,000 of this income getting taxed at 32.5% – i.e. £325 (£2,000 is covered by your annual tax-free allowance). In the same year, you decide to sell shares totalling £100,000 in gains. After your £12,300 annual tax-free allowance for capital gains, this leads to a tax bill of £17,540 – i.e. 20% on £87,700; enough to wipe out years of investment growth. In total, these taxes amount to over £90,000 in a single tax year.
Keeping these investments within an ISA framework, however, could significantly reduce these kinds of taxes. This is because any savings and investments held within an ISA are free from taxes on capital gains, dividends and savings interest.
Making the most of an ISA
Suppose the person in the aforementioned scenario sold those £100,000-worth of share gains from within an ISA. That would mean zero capital gains tax (CGT) as opposed to £17,540. Yet it is not as simple as just moving all of your investments into an ISA. After all, in 2021-22 there is a £20,000 annual limit on your ISA contributions. This is one reason why it is so important to make the most of your allowances each tax year. Over time – e.g. 5, 10 or more years – it would be possible to move significant sums into an ISA structure, allowing you to eventually sell any gains and receive dividends without tax.
Before you rush to move everything into an ISA, however, consider speaking to your financial adviser about the best way to approach things in light of your wider financial plan. Bear in mind factors such as the following:
- Inheritance tax. In 2021-22, you can pass down your defined contribution pensions to loved ones as an inheritance – free from tax. Savings and investments held within an ISA, however, are not exempt. As such, would any money you are considering putting into an ISA be better placed into a pension?
- Income tax. Money placed into an ISA has usually already been taxed as income from your salary. If you are a Higher Rate taxpayer, for instance, then you may first pay 40% on an amount of money which you then put into an ISA. Pension contributions, however, receive tax relief at your highest rate on income tax – putting the money you would have paid in tax, instead, straight back into your pension. For someone on the Higher Rate, therefore, this amounts to a 40% free government “top up” on your contribution. In light of this, could you save more tax by putting more money into a pension – or an ISA?
- Timing. Setting aside your ISA for a moment, each year you are entitled to certain tax allowances which refresh the following year. In 2021-22, for instance, you can earn up to £12,300 in gains, CGT-free. If you can afford to wait and spread out selling your gains across multiple tax years, therefore, then you make the most of this allowance and save significant sums in CGT before your ISA is even brought into the picture. However, this is not always possible with large gains from certain assets – e.g. selling a property.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk