How to make the most of your tax free allowances

The current tax year (2020-21) will end on 5 April 2021 and we are all expecting tax increases shortly to help recover the cost of COVID-19. This means that even more than usual, it is important to be making the most of existing tax allowances and reliefs in the current tax year.

Things to consider include making sure you have utilised your personal allowance, maximised your pension contributions, utilised your capital gains tax annual exemption where possible, and your annual inheritance tax gift exemption.

Some tax planning opportunities to consider are:

Avoid the 60% tax rate

Currently the personal allowance is £12,500 for those with taxable income of up to £100,000. For earnings between £100,000 and £125,000 the personal allowance is tapered, which has the effect of creating a 60% tax rate for income in that bracket. To avoid getting hit by this top rate of income tax, you can make pension contributions and charitable donations to reduce taxable income levels.

Give it away

If you gift cash to UK registered charities, they can get tax relief in the form of Gift Aid and you can claim higher rate tax relief. The same applies to charities registered in the EU, Norway, Iceland, and Lichtenstein, provided they meet certain conditions.

Gift Aid works as follows:

A 40% taxpayer gifts £1,000 in cash to a charity under Gift Aid. The charity can reclaim £250 from HMRC, making the donation £1,250 gross. The donor can claim tax relief on the difference between the rate they pay and the basic rate on the gross donation, so £250 (£1,250 x 20%).

Invest in tax advantaged schemes

Subject to having the excess income and the necessary risk profile, it can be very tax efficient to invest in tax advantaged schemes like EIS or SEIS, or in VCTs. This is because you can claim tax relief on the investment and there is no capital gains tax to pay on profits in the future, subject to meeting the necessary criteria. It is also possible to freeze tax payable on other gains by investing in these types of tax advantaged investments.

Top up your ISA

There are now a variety of different ISAs to choose from, and the amounts to be invested have increased considerably. Each UK taxpayer aged 18 or over has an annual allowance of £20,000 to invest in an ISA every year and can spread their allowance across a range of options including savings accounts and shares. It is also possible to invest in a separate ISA for children or grandchildren.

Types of ISA
1. Cash ISAs – like a savings account but interest earned is tax-free;
2. Help to Buy ISAs – for first time buyers, if you have one already you can continue saving £200 a month;
3. Stocks and shares ISAs – for investments in shares, bonds, and investment funds;
4. Lifetime ISAs – save or invest up to £4,000 of your annual ISA allowance and the government adds a 25% bonus at the end of every tax year until you reach 50 years of age. This money is available either to buy a property or to withdraw after age 60;
5. Innovative finance ISAs – get tax-free returns on peer-to-peer lending or crowdfunding campaigns;
6. Junior ISAs (JISAs) work like adult accounts but are for under 18s with an investment limit of £9,000.

Boost your pension

In the tax year 2020-21, if you are a UK taxpayer you will get tax relief on pension contributions of up to 100% of your taxable earnings or a £40,000 annual allowance, whichever is lower.

Provided you are already a pension scheme member, it is possible to increase your allowance for this year by using any previous unused entitlement from the past 3 years.

For people with income between £150,000 and £210,000, the allowance has been eroded by new rules which came into operation in the 2016/17 tax year. The result of this is a £10,000 allowance for anyone earning £210,000 or more. On 6 April 2020 further new rules came into operation which increased the upper income threshold to £240,000 and reduced the minimum annual allowance to £4,000.

Pensions can also be funded for children.

Use your CGT annual exemption

Everyone has an annual capital gains tax exemption of £12,300 per annum but if it is not used it is lost. Consider whether you can use this before the tax year-end.

Use your IHT annual gift exemption

Individuals can give away £3,000 each tax year without any inheritance tax implications; the previous year’s exemption can also be used if it remains unused.

The budget is on 3 March 2021 and after that it will be important to consider whatever is announced and put longer term plans in place for the 2021-22 tax year, beginning on 6 April 2021. In the meantime, if you would like advice on making the most of your tax free annual allowances before the end of the current tax year, please contact partners@rjp.co.uk.