Start your 2020-21 tax planning now
What isn’t as commonly known, however, is that April also represents the cut-off point for many unused tax allowances. Take your ISA (individual savings account) as an example. At present, you are allowed to save up to £20,000 per tax year into your ISA(s). The money you place into this “wrapper” is then shielded from tax. If your ISA generates interest, for instance, then this will be tax-free (even if your earned interest outside of your ISA has exceeded your £1,000 Personal Savings Allowance). The same applies to dividend income earned or capital gains made from your ISA investments.
Just as any unused ISA allowance for 2019-20 will have expired by the 6th April 2020, the same will apply at the end of the next financial year (unless the rules change). You will be unable to “carry over” any unused allowance into the 2020-21 tax year. So, if you want to avoid trying to frantically scramble any assets together at the nth hour in March 2021, consider already making a plan for the year ahead. Speak to your financial adviser about how to gradually leverage your ISA allowance across the tax year, if you are able to do so. Consider the impact that would have over ten years, where one might accrue up to £200,000 in tax-free savings and investments!
There is still a perception in the UK that retirement could be funded later in life; perhaps using the proceeds from selling a business or second home. Such plans are often complicated by the UK’s annual allowance rules, which in 2019-20 limit each person to contributing up to £40,000 (or up to 100% of their earnings) into their pension per tax year. This isn’t to say that a future house or business sale couldn’t form an important part of a retirement plan. However, it might not necessarily be the most tax-efficient strategy in the long term.
Similar to the ISA situation outlined above, moreover, the 6th April 2021 arrives the opportunity to contribute up to £40,000 (or 100% of your earnings) for the 2020-21 tax year will close. You then have another twelve months to make use of your new annual allowance. For higher earners in particular, it’s important to not miss the opportunity to make important decisions in the coming weeks which could have a big impact on your lifestyle in retirement.
Under current rules, Basic Rate taxpayers receive 20% tax relief on their contributions, whilst those on the Higher Rate benefit from 40% tax relief. For the latter, therefore, for every £100 you put into your pension the government will give you £40 extra (i.e. £480 per year).
This tax relief can add up to significant wealth growth over the long term, even when excluding growth from the compound interest generated by your investment returns.
Under the current rules, you are allowed to carry forward any unused allowances from the previous three tax years subject to not contributing more than 100% of earnings. However, bear in mind that this still means that April 6th represents closure on any unused allowance from four years ago. So if you have a large sum of spare cash sitting in a regular savings account (e.g. from recently coming into an inheritance or selling a high-value asset), consider speaking with your financial adviser about whether any of this capital could be committed towards your long-term future via a pension fund.
Susan earns £140,000 per year in her senior sales job. She has already contributed £10,000 into her pension, which means she can contribute a further £30,000 for the 2020-21 tax year (assuming the money purchase annual allowance doesn’t apply). Susan also has £25,000 carry forward available from the past three tax years, which means she could contribute up to £55,000 before the 5th April 2021.
Assuming Susan can afford to commit the full gross amount to her money purchase pension (and her provider’s requirements allow her to do so), she will immediately get 20% tax relief at source, representing £11,000. Provided she submits a self-assessment tax return specifying her contribution, a £11,000 higher rate tax relief can be attained. From there, she can reduce her tax bill by a further £3,000 by reclaiming £7,500 from her income tax personal allowance.
Taken together, by acting before the 5th April deadline Susan achieves 45.5% tax relief.
For more help on making the most of your tax allowances, please do get in touch with one of our local advisers.
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