Year-end personal tax planning

March 6th, 2011

Given that 5th April 2011 signals the end of the current tax year, this article focuses on some tax planning opportunities before then and covers some important changes that will take effect from the 2011/12 tax year.

Pension Contributions and Tax Relief

If you are under 75, pension contributions should be considered because of the tax-relief available.  The maximum personal contribution on which you can receive tax relief is the greater of £3,600 and 100% of your ‘relevant’ UK earnings and even though only 25% of the fund at retirement can normally be taken as a tax-free lump sum (compared to 100% with an ISA), the funds grow virtually tax-free and any lump sum paid on death before age 75 should also be tax-free as long as it is within your available lifetime allowance (currently £1.8m)

Specific considerations for High earners

If you are earning over £100,000 your personal allowance is reduced by £1 for every £2 your income exceeds this threshold.  You could, however, restore your Personal Allowance and potentially achieve up to 60% effective tax relief by making a pension contribution.

It is important to seek specialist advice in this area though if your total income in either the current or previous two tax years has been £130,000, or more. This is because, up until 5 April 2011, tax relief on pension contributions in excess of £20,000 is generally restricted to 20% for high earners. This is a complex area, but even if you are affected by these rules and want to make a significant additional contribution it may still be worth doing this before 6 April 2011 even if tax relief is restricted on this amount as such a contribution will still benefit from basic rate tax relief whereas, after 5 April 2011 if total contributions in a tax year exceed £50,000 the excess above this may not benefit from any tax relief at-all.

Furthermore, if your total income is more than £130,000 in 2010/11 but was less than this in 2008/09 and 2009/10, consideration should be given as to whether making pension contributions and/or gift aid contributions can reduce your ‘relevant’ income to less than £130,000 – in which case you would not then have to worry about the restriction of tax relief on pension contributions at all.

Remember that a correctly timed contribution to a pension can be useful in reducing or eliminating an income tax liability on an investment bond gain or the rate of capital gains tax due on the disposal of assets such as unit trusts or shares.

ISAs

Have you made use of your ISA allowances for the current tax year?

Individuals who pay tax should always consider trying to maximise the contributions they make to an ISA because even though tax relief is not received on the contribution, any growth on the investment is in a tax-efficient environment and benefits can be drawn tax-free.

In 2010/11, the maximum contribution is £10,200, of which £5,100 can be paid into a cash ISA.

Capital Gains Tax

Another simple tax planning technique is the use of the annual tax-free allowance for capital gains .  It is possible to realise gains of up to £10,100 in the tax year before CGT becomes payable.  Unused  annual allowances cannot be carried forward , so you may want to consider reviewing your portfolio to see if some gains can be triggered and realised tax-free.  To add an element of sophistication, you could also review whether there are any investments standing at a loss, which could be sold to realise the loss and offset against gains beyond the allowance. For example, a £15,000 gain combined with a £4,000 loss gives you a net taxable gain of just £11,000.

Spreading gains over two or more tax years can help make use of multiple tax-free allowances (for example, by selling half of an investment on 5 April and the other half on 6 April) and because your spouse will also have an allowance each tax year, you can transfer assets tax-free to your spouse, who can then sell them to use their own allowance – thus doubling the tax free amount

Remember, for any disposals made on or after 23 June 2010, the rate of CGT has increased from 18% to 28% for a higher rate tax payer, so gains beyond the annual exemption are best realised in a spouse’s name if that spouse is  a non, lower or basic-rate taxpayer.

Transferring existing unit trusts into an ISA or SIPP (self-invested personal pension) are also ways of utilising your CGT exemption that can be discussed with your financial adviser.

EIS and VCT Investments

Other tax planning opportunities to take advantage of are specific tax breaks introduced to encourage particular investment behaviour and/or compensate for extra risk.  The tax breaks are annual, so there are only a few weeks left to take advantage of the 2010/11 reliefs.

It is possible to invest up to £500,000 in new shares issued by qualifying companies under the Enterprise Investment Scheme (EIS), and obtain 20% income tax relief on the investment.  EIS investments can also be used to defer capital gains made in the period one year before and up to three years after the date the investment is made and EIS shares themselves are also exempt from CGT if they are held for at least 3 years.

Investments of up to £200,000, which provide 30% income tax relief, can also be made into Venture Capital Trusts (VCTs). Whilst, however, there is no CGT deferral relief the shares themselves are exempt from CGT.

The high risk attached to them will make them unsuitable for the vast majority of investors.  These investments also need to be held for certain minimum periods or income tax relief will be clawed back so it is strongly recommended that professional advice is sought before considering investing in either.

Inheritance Tax reliefs

One of the simplest methods of inheritance tax planning is to make full use of this year’s annual £3,000 exemption and any unused exemption from the previous year. You must use the current year’s exemption, before using any of the available previous year’s.

Gifts to spouses, irrespective of the size, are also exempt if the spouse is domiciled in the UK and the smalls gifts exemption of £250 per individual each tax year should not be overlooked either.

Don’t forget that any regular gifts you make out of any surplus income can also qualify as exempt transfers

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.

Investments in stocks and shares do not have the same degree of capital security as investments in deposits.  The value of your investment can go down as well as up and you may not get back the full amount invested