SAVVYWOMAN GUIDE TO SAVING TAX

1

WRITTEN BY SARAH PENNELLS, EDITOR OF SAVVYWOMAN.CO.UK

SPONSORED BY

This is a short guide to saving tax to complement the SavvyWoman Saving Tax Event on March 28th, which included presentations by Anna Sofat from Addidi, Jeannie Boyle and Katherine Lindley from EQ Investors and Sarah Lockyer from Nockolds law firm. The event was kindly sponsored by Addidi, EQ Investors and Nockolds.

This isn’t meant to be a comprehensive guide to tax planning and tax saving, but I hope it gives you some food for thought. Thanks to Addidi, EQ Investors and Nockolds for information and tips.

A GUIDE TO THE TAX WRAPPERS AVAILABLE

A tax wrapper is a way of investing while saving tax. There are several different tax wrappers available. The main ones are:

ISAS (INDIVIDUAL SAVINGS ACCOUNTS)

These are probably the best known tax wrapper. If you have an ISA you can save or invest tax efficiently. You can take out cash ISAs through banks or building societies and stocks and shares ISAs direct from fund management companies, through platforms (these let you buy and own a variety of investments) and via an IFA (independent financial adviser).

How do they save tax? If you have a cash ISA, the interest you earn is tax free, no matter how much you have saved. If you have a stocks and shares ISA, there’s no tax to pay when you cash it in.

SAVVY TIP: Addidi says you can also leave your ISA to your husband, wife or civil partner, and there’s no inheritance tax to pay.

How much can you save or invest? You can save or invest up to £20,000 in tax year 2017 – 18. This includes money you save in a cash ISA, money you invest in a stocks and shares ISA and money you have in a lifetime ISA (if you qualify for one).

Flexibility: You don’t have to save or invest for a minimum term, unless the product says you must. For example, if you save in a three year fixed rate cash ISA, you’d have to keep your money in the cash ISA for three years. You can also transfer your cash ISA between different providers or to a stocks and shares ISA. You can also do the transfer the other way, from a stocks and shares ISA to a cash ISA.

2

Different types of ISAs: There are variations on ISAs, such as a cash ISA and a stocks and shares ISA. Here the variation is based on what you can save or invest in. But there are also variations in ISA in terms of what the ISA is designed for. For example, a help to buy ISA is a cash ISA that lets you save towards a deposit for a property if you’re a first time buyer. From April 6th you may also be able to take out a lifetime ISA, which lets you save or invest for a first home or for your retirement. However, you can only take out a lifetime ISA if you’re aged between 18 and 39. At the moment you can only take out stocks and shares lifetime ISAs, but in the future it is likely that you’ll be able to take out a cash lifetime ISA as well.

A help to buy ISA is a cash ISA, and you can only have one cash ISA a year – so if you have a help to buy ISA, you can’t normally take out a cash ISA in the same tax year as well.

SAVVY TIP: Some banks and building societies, such as Nationwide and Aldermore Bank let you have a help to buy ISA and a cash ISA under the same umbrella. This means you can have two cash ISAs in the same tax year and not break HM Revenue & Customs’ strict rules. But most banks don’t let you do this.

PENSIONS

It’s often said that pensions let you save for your retirement, but they really let you invest for your retirement.

How do they save tax? Pensions are tax efficient for two reasons. Firstly, you get tax relief on money you pay in. What that means in English is that you get a top up from the government, which uses some of the tax you would have paid it to add to your pension.

Depending on the kind of pension you have the tax relief may be paid in different ways. But the principle is the same. If you’re a basic rate taxpayer, you’ll get tax relief at 20%. Possibly confusingly, it means an extra 25% is paid into your pension. So, if you pay in £80, another £20 is paid in from the tax relief, giving you £100 in all. Putting it another way, paying £100 into your pension only costs you £80.

If you’re a higher rate taxpayer, you get extra tax relief, as long as you claim it. If you have a personal pension, you don’t get this extra tax relief paid straight into your pension. Instead, if you fill in a self assessment form you generally claim the additional tax relief then.

3

You can take out up to 25% of your pension as a tax free lump sum. If you’re taking a number of cash lump sums from your pension, the first 25% of each one is tax free.

In addition, there’s no inheritance tax to be paid by your heirs on the pension they inherit when you die. If you die before the age of 75, there’s no tax for them to pay at all. If you die after the age of 75, your heirs will pay income tax on any pension they receive.

How much can you invest? You can invest up to 100% of your earnings, or £40,000, whichever is the lower figure.

SAVVY TIP: If you don’t pay tax, you can still contribute up to £3,600 a year (or £2,880 before tax relief) into a pension.

If you have a personal pension or a defined contribution (otherwise called a ‘money purchase’) workplace pension, the £40,000 annual limit figure is easy to work out. But

SAVVY TIP: Addidi says that if you have a final salary or other salary-related pension, it’s more complicated. That’s because the figure relates to the pension you’ve built up or accrued, not the amount you and/or your employer have paid in.

If you earn more than £150,000 a year, you can’t pay in £40,000 to your pension and get full tax relief. Instead, there’s something called ‘taper relief’. It means that for every £2 you earn over £150,000, the amount you can invest in a pension every year is reduced by £1.

The most your allowance is reduced by is £30,000. So, if you earn more than £210,000 (£60,000 more than £150,000), you can only pay £10,000 a year into your pension and get tax relief (£40,000 annual pensions allowance minus the maximum deduction of £30,000).

SAVVY TIP: You can also go back over the last three tax years and make extra pension contributions of up to £40,000 a year (or 100% of your salary). It’s called ‘carry forward’. You can only do this if you’ve already paid in the maximum amount of pension contributions in the current tax year.

In theory you can pay up to £40,000 a year into your pension until you’re aged 75. But you lose this allowance once you’ve flexibly accessed your pension. In that case, you have what’s called an MPAA (money purchase annual allowance), currently £10,000 a year. It was due to fall to £4,000 but this is delayed due to the snap election.

4

There’s also a lifetime limit, which is currently £1 million, which is the maximum you can pay into your pension over your lifetime, and get tax relief.

Flexibility: If you’ve signed up to a workplace pension, you generally have to pay into it every month. You may be able to leave and rejoin the scheme but check with the pension scheme for the rules. If your workplace pension is an automatic enrolment one, you can opt out of it in the first month. Personal pensions generally let you pay in monthly premiums, lump sums and stop and start contributions.

Pensions are inflexible to the extent that you cannot get access to your money until you’re 55 or older (unless you’re gravely ill). However, you can take money out of your pension flexibly once you reach the age of 55, as long as it’s not a final salary pension.

Different types of pension: There are different types of pensions, including ones that you can take out through your workplace and personal pensions, which you take out directly with a pension company or through an independent financial adviser. Within these broad categories there are further variations.

Pension terms you may come across include final salary (or defined benefit) pensions, money purchase (or defined contribution) pensions, personal pensions, stakeholder pensions (which were set up as low cost workplace or personal pensions – although costs have come down so much that they’re not particularly low cost anymore).

SIPPs (self invested personal pensions) are personal pensions that give you more choice about what you invest in. They can be more expensive than regular personal pensions, so make sure you are going to use the extra benefits they come with.

BONDS

The word ‘bond’ crops up in various guises in financial services and it usually means completely different things. In this case, the bond being referred to is an investment bond. Investment bonds are normally sold by insurance companies or through independent financial advisers. They normally include an element of life insurance in them and you usually pay for them with a lump sum.

5

How do they save tax? They can be tax efficient because you can take out up to 5% a year without paying any tax at the time. It doesn’t mean the money you withdraw is tax free, just that the tax isn’t payable at the time you withdraw it. This can be useful if you’re a higher rate taxpayer when you take the bond out but you know you’re going to be a basic rate taxpayer by the time it matures, for example.

SAVVY TIP: If you don’t take out 5% one year, you can roll this over for another year. So, if you took nothing out one year, you could take out 10% the next year with no tax to pay at the time.

When the bond matures or you cash it in, tax will have been paid at the basic rate, so if you’re a non-taxpayer or a basic rate taxpayer, there’s no extra tax to pay. If you’re a 40% or 45% taxpayer when the bond matures, you may have to pay extra tax.

How much can you save or invest? There’s no annual investment bond allowance as there is with an ISA, but there’s often a minimum amount that you need to invest. This varies depending on which company you buy the bond from and the exact product you’re buying.

You can buy onshore investment bonds and offshore investment bonds. Offshore bonds are issued from locations such as the Isle of Man or the Channel Islands. The minimum investment amount may be higher with an offshore bond compared to an onshore bond.

Flexibility: Investment bonds normally run for a set term if you cash in the bond early, you may have to pay charges. You can’t stop or start your payments as you normally have to pay a single lump sum.

Different types of investment bonds: There are onshore and offshore investment bonds. The investment bond may be a ‘with profit’ fund, which means that the ups and downs of the stock market are smoothed out (the return is provided through an annual bonus, which is not guaranteed), or unit-linked, where the value can rise and fall –possibly quite dramatically.

EIS/SEIS

Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS) are tax efficient, but they are also higher risk. That’s because they generally invest in higher risk businesses or start ups.

6

They are best suited to people who have a lot of money to invest and who are comfortable with the risks. If the companies you invest in do well, you could get a high level of return, but it’s not guaranteed and you should only invest a small amount of your portfolio, even if you’re comfortable with higher risk investments.

How do they save tax? As long as you keep your money invested in the EIS scheme for at least three years, you can reduce your income tax liability by 30% of the amount you’ve invested. If it’s an SEIS scheme, the tax relief is 50%. There are other conditions that you have to fulfil: for example, you cannot hold more than a 30% interest in a company if it’s an EIS.

You also don’t pay capital gains tax on EIS or SEIS investments if you hold them for at least three years. There are some other capital gains tax benefits as well. You can read more about EIS in my article: https://www.savvywoman.co.uk/1054/investing-in-young-businesses-is-risky-but-tax-efficient-enterprise-investment-schemes-can-cut-the-risk

How much can you invest? The maximum you can invest in EIS is £1 million (or £2 million for married couples). The maximum you can invest in SEIS is £100,000.

MAKING USE OF TAX ALLOWANCES

As well as specific tax efficient investment and savings ‘wrappers’ there are a number of tax allowances you can use. They are:

• Personal tax allowance: You can earn up to £11,500 in the current tax year (2017 – 18) before you have to pay income tax. The 40% tax rate (higher rate) kicks in on income above £45,000. The additional rate of tax, is payable at 45% on your income above £150,000.

SAVVY TIP: EQ Investors say that if your income is just over £45,000, you could make a pension contribution or charitable donation to reduce it below the 40% level. It’s especially useful if you have savings where you generate more than £500 a year in interest because you’ll be able to get the full £1,000 personal savings allowance (see below).

If your income is above £100,000, you’ll begin to lose the personal tax allowance. For every £2 of income you receive over £100,000, you’ll lose £1 of the personal allowance. If you earn £123,000 or above, you won’t receive any personal allowance.

7

• Personal savings allowance: This lets you earn up to £1,000 a year in savings interest (£500 if you’re a higher rate taxpayer and nothing if you’re an additional rate taxpayer), without having to pay tax. If you earn more than £1,000 a year in interest from your savings, you must pay tax on the rest, either through PAYE or a self assessment form. Learn more about this in my article: https://www.savvywoman.co.uk/6316/tax-free-savings-allowance-interest-of-up-to-1000-a-year-tax-free

• Dividend allowance: You can take up to £5,000 a year in dividend income without paying tax. This was set to fall to £2,000 from April 6th 2018, but has been delayed by the snap election. If you receive more than £5,000 a year in dividend income, you’re taxed at 7.5% if you’re a basic rate taxpayer. You have to pay tax at 32.5% if you’re a higher rate taxpayer and 38.1% if you’re an additional rate taxpayer. Read more about the dividend allowance in my article: https://www.savvywoman.co.uk/6519/how-dividends-are-taxed-from-april-2016

SAVVY TIP: EQ Investors say that if you have investments that you currently don’t hold within an ISA, you can sell them and then buy them back in your ISA to protect the dividends from tax. It’s called ‘bed and ISA’.

• Capital gains tax allowance: Everyone gets an annual capital gains tax (CGT) allowance. In the tax year 2017 – 18 it’s £11,300. That means you can make £11,300 profit (after certain expenses) without paying capital gains tax. If you sell shares or other investments that aren’t held with a tax-efficient wrapper such as an ISA, you pay capital gains tax at 10% if you’re a basic rate taxpayer, or 20% if you’re a higher rate taxpayer. If you’re selling an investment property, you pay CGT at 18% for basic rate taxpayers and 28% for higher rate taxpayers.

You can make use of your capital gains tax allowance by selling shares so your profit is just below the CGT allowance limit. If you need to sell more shares, it’s worth seeing if you can do this across more than one tax year, to reduce your CGT bill.

SAVVY TIP: EQ Investors say that if you’ve invested in shares that have produced a loss, the losses can be deducted from any gains. It’s important to report any losses to HM Revenue and Customs. That way the loss is deducted from any gains made in the same tax year. You can claim the loss up to four years after the tax year that you sold the asset.

8

It’s probably worth taking advice from an independent financial adviser or stockbroker unless you’re sure you know what you’re doing. You may end up selling too many shares.

You can also transfer shares to your husband, wife or civil partner to make use of his or her CGT allowance. But this does mean you’ve given them away. It’s not a loan!

You can read more in my article: https://www.savvywoman.co.uk/606/capital-gains-tax-and-investments-how-much-capital-gains-tax-do-you-have-to-pay

9

INHERITANCE TAX

Inheritance tax is generally not paid by the person who owns the assets or dies. Instead, it’s paid by their executors (if they have a will) or administrators if they have no will out of the estate.

It is charged at a rate of 40% on assets you own when you die that are worth more than £325,000. Except it’s not quite that simple (of course!). Wives, husbands and civil partners can leave as much as they want to each other when they die and there’s no inheritance tax to pay.

If you have assets worth more than £325,000 and you are a widow, widower or survivor or a civil partnership, your executors or administrators can claim any unused part of your late husband, wife or civil partner’s inheritance tax allowance (otherwise called the ‘nil rate band’) when you die. This effectively means a married couple can leave £650,000 without any inheritance tax needing to be paid.

From April 6th 2017, there’s a new IHT allowance, which some married couples and civil partners will be able to claim. In order to benefit from the new residential nil rate band (RNRB), you’ll have to pass your main home onto your children or grandchildren (or certain other close relatives, but NOT all).

By 2020, this residential nil rate band will be worth an extra £175,000 for each partner, giving a total of £500,000 each once you add in the inheritance tax allowance of £325,000, or £1 million for a married couple or civil partners.

You can read more about how the new inheritance tax allowance works in my article: https://www.savvywoman.co.uk/11398/make-sure-get-new-1-million-inheritance-tax-allowance-home

Here are five inheritance tax saving tips from Nockolds:

1. Be married! Couples who live together but who aren’t married can’t leave assets to each other free of inheritance tax in the same way that married couples and civil partners can. They also can’t transfer their nil rate band, as I’ve described above, or take advantage of the residential nil rate band.

10

2. Give money away while you’re alive. You can give away up to £3,000 in any one tax year and you can also give away small gifts of up to £250 to anyone you like. If you have a son or daughter who’s getting married, you can give them up to £5,000 and you can give away £2,500 to a grandchild or great grandchild.

However, you can’t give that person £250 and also give them £3,000 (or part of your £3,000 allowance), or a wedding gift of £5,000 or £2,500. With the £250 allowance, it has to be either/or.

You can also give away gifts out of income (such as for birthdays or Christmas, or to help with your grandchild’s university costs, for example). But these must be affordable and you should keep good records of the money you’ve given away.

3. Be aware of the ‘seven year rule’. You can give away more than £3,000 as long as you live for seven years after you’ve given it away. It’s called a potentially exempt transfer or PET. There’s a sliding scale of rates at which inheritance tax is charged depending on how long you live for after you’ve made the gift (but ONLY if tax is payable on that gift). As long as you live for at least three years after you’ve given away the gift, you’ll have reduced your inheritance tax liability.

SAVVY TIP: You can’t give something away to avoid inheritance tax and still make use of it. So, for example, you can’t give away your home and carry on living in it.

4. Give money to charity. Any money you give to charity is exempt from IHT. However, Nockolds says that this only applies to a charity established in the UK or another European Economic Area country (that’s the EU plus Norway, Iceland and Lichtinstein). If you leave 10% of your assets to charity when you die, everyone who inherits pays inheritance tax at a rate of 36% and not 40%.

5. Vary an inheritance. It is possible to change a will after someone has died. It must be done within two years of the person dying and anyone who would be worse off as a result of the will changing has to agree to it. You can read more about changing a will after someone’s died in my article: https://www.savvywoman.co.uk/5938/changing-a-will-after-someones-died-using-a-deed-of-variation

11