Tax, investments & allowances: Making the most of your money in 2021
6th May 2021
Samantha Gratton See profile
Despite good intentions, the end of the tax year seems to come around more quickly each year and given many of the tax and investment allowances fall under the category of use them or lose them, this can often lead to a last-minute rush before the 5 April deadline.
Now we are at the beginning of a new tax year coupled with the need for the Government to raise additional finance, it’s a good time to review whether you’re making the most of the allowances available and where appropriate, are taking earlier action this year.
In this article we talk about the following areas:
This means someone can receive a taxable income of up to £50,270 this year before incurring higher rate tax of up to 40% on income over this threshold. The personal allowance and basic rate and higher rate tax thresholds will remain frozen at these levels for tax years up to and including 2025/26 so it’s possible that a lot more people will find themselves becoming higher rate taxpayers.
With careful planning, it’s often possible to limit the impact of incurring additional tax on pensions and investments.
In terms of general planning, couples should aim to utilise both personal allowances, starting/basic rate tax bands as well as the dividend allowance of £2,000 and personal savings allowances of up to £1,000 to the full.
For those who are married or in a civil partnership, you can consider an unconditional transfer of an appropriate amount of their dividend or interest producing investments to ensure each of a couple maximise use of these allowances. It’s important to note however, that any such transfer must be made on a ‘no-strings-attached’ basis to ensure that the desired tax outcome is achieved.
There is also a transferrable marriage allowance for those who are married or in a civil partnership. To qualify, both partners must not be liable to pay tax above the basic rate so it’s possible to transfer 10% of the personal allowance (£12,570 in 2021/22). The transferor’s personal allowance is reduced by the transferred amount – £1,257 in 2021/22. The transferee is entitled to a tax reduction of 20% of the transferred amount (i.e. £251 in 2021/22).
If not claimed in the previous tax year, the claim can also be backdated one tax year had the couple also been eligible to claim the marriage allowance in that year. The marriage allowance can be claimed online at www.gov.uk/apply-marriage-allowance, by telephone or by letter.
By saving regularly towards their future, families can give children a significant financial asset when they reach adulthood – helping them into higher education, training, or work. Junior ISAs (JISAs) and Child Trust Funds (CTFs) are tax-advantaged accounts for children, designed to encourage a long-term savings habit through tax efficiencies. No new CFTs can be set up but contributions can continue to the established ones.
JISAs can only be established by parents or legal guardians though anyone can then contribute. They’re particularly attractive to parents, where the investment does not end up being taxed on them for the under 18’s once interest is above £100, as would be the case for a normal child’s deposit account. For Grandparents, gifts to these accounts can also be a good way to use Inheritance Tax allowances which can allow gifts to be immediately free of Inheritance Tax.
Parents should be aware that the child will become (in effect) fully entitled to the JISA at age 18.
Lifetime ISA (LISA)
This can be a particularly attractive option for parents and grandparents who are looking to help children and grandchildren save for a deposit for their first property.
The annual limit remains £4,000 each year, with contributions possible until age 50 with the Government adding a 25% bonus to savings, up to a maximum of £1,000 per year. This means for every £4,000 gifted, £5,000 will be invested in the LISA. This limit of £4,000 counts towards the annual ISA limit.
You can hold cash or stocks and shares in a Lifetime ISA, or have a combination of both. It’s therefore an ideal vehicle for longer term investment as well.
Capital Gains Tax
Making use of the annual exemption
The CGT annual exemption is given on a ‘use it or lose it’ basis and with a consultation on the tax suggesting that the allowance should be cut and the tax rates aligned with Income Tax, it may be especially prudent to use this particular allowance early.
It may also be possible to maximise the tax-free element of a larger gain by ensuring that investments are held jointly with a spouse or civil partner, so that two annual exempt amounts are available to offset against any gain on disposal. Any transfer between spouses/civil partners must, of course, be unconditional to be effective.
Your financial planner can advise you on how best to take advantage of the exemption but also, incurring some CGT can still be beneficial given the rate of tax for basic and higher rate taxpayers is half the rate of tax on income at 10% and 20% respectively.
Maximising the use of losses
The recent equity market volatility may mean that some of your holdings could be standing at a loss.
If a taxpayer has realised a gain and a loss in the same tax year: the loss will be set off against the gain, even if the gain is within the taxpayer’s annual exemption. Some or all the exemption may therefore be wasted.
However, if the taxpayer carried forward a loss from a previous tax year: the carried forward loss is only used up to the extent that it reduces their overall gains to the level of the annual exemption. The loss is therefore only partly used when necessary, with the balance carried forward to set off against gains in later tax years.
Care should therefore always be taken before realising gains and losses together in a single tax year so as not to inadvertently waste the annual exemption.
The IHT nil-rate band which has not changed since 2009 will continue at £325,000 and the residence nil-rate band at £175,000.
The Office of Tax Simplification (OTS) has published two reports on IHT, the first, covering administrative issues, in 2018 and the second, covering the tax itself, in 2019.
Following the first OTS report, the Government has now announced that from 1 January 2022, return procedures will be simplified so that ‘over 90% of non-taxpaying estates’ will no longer have to complete IHT forms when probate or confirmation is required.
And the Government said it will respond to the many simplification recommendations made in the second OTS IHT report (such as replacing the multiplicity of lifetime gift exemptions with a single, larger personal gift allowance) ‘in due course.’
We can only speculate what the Government may be planning with regards to IHT reforms but in the meantime, it would seem sensible to take advantage of the tax reliefs currently available in case they may be withdrawn in the future.
One of the main allowances available is the £3,000 annual exemption. If you don’t utilise this allowance in one tax year it can be carried forward a year. As a couple, this means you will usually be able to give away £6,000 and potentially £12,000 if you haven’t made a gift the year before.
Small gifts allowance
The small gifts allowance allows you to make as many gifts of up to £250 per person as you want, although this cannot include someone you have used another allowance on.
Gifts out of normal expenditure
Regular gifts out of normal income can be very tax efficient if structured properly. These gifts are immediately out of your estate as long as you’re able to maintain your standard of living allowing for the regular gifts without having to draw on additional capital. This is particularly useful if you have surplus income over expenditure that would otherwise build up within your estate.
It’s worth bearing in mind that your executors will need to prove to HMRC that these gifts fulfil their criteria, so it’s worth keeping a record of your available income/cash flow each year.
Gifts in respect of marriage
If congratulations are in order, you can make wedding or civil ceremony gifts of between £1,000 and £5,000. A gift would need to be made before the wedding and the wedding does need to go ahead!
When someone makes a gift in excess of the amounts above to an individual, this is regarded as a Potentially Exempt Transfer (PET) for IHT. This means that if the person making the gift survives for seven years from the date of the gift, it will become exempt from IHT. However, if they pass away before seven years has passed, the amount of the gift will still be included in their estate in calculating the IHT due. It’s worth bearing in mind that such gifts are unlimited. In some circumstances, it can be beneficial to organise such gifts via a Trust and your financial planner will be able to advise on the merits of this in relation to your own circumstances.
IHT is a complicated subject with substantial tax savings potentially available and your financial planner can undertake an estate review if you wish.
The Lifetime Allowance
The Chancellor confirmed at the budget that the Lifetime Allowance (LTA), the maximum pension fund that an individual can have without additional tax applying, will be frozen at £1,073,100 until April 2026.
The change has little immediate impact as due to low inflation, the LTA was only expected to increase by around £5,800 in 2021/22.
A much bigger issue will be the removal of future inflationary increases. If the LTA had continued to be uplifted with inflation, it would have increased to around £1.2 million by April 2026. It will now be around £125,000 less than this meaning additional tax could be incurred of up to £68,750 and for those with pension funds at this limit they would miss out on up to £31,250 of extra tax-free cash. With inflation possibly rising, the loss could be much more than this.
The Telegraph highlighted over the weekend in their article ‘How middle England can avoid a 55pc pension tax hit’ that even those with pension funds of £500,000 or £600,000 are projected to breach the allowance in the future even if their investments only grew at modest rates.
Constant tinkering with pension rules has created a great deal of uncertainty for those approaching retirement and we may yet see further changes when the Government starts to raise money to repay the high level of borrowing caused by the coronavirus.
The LTA has fallen from £1.8 million ten years ago to a low of £1 million in the 2016/17 tax year before starting to rise by inflation.
|Tax year||Standard lifetime allowance|
|2020/2021 until 2025/2026||£1,073,100|
The LTA is a complex area as the Government has introduced various protections down through the years that people have been able to take advantage of to secure a higher allowance.
If you already have protection in place to receive a higher lifetime allowance, it’s important to ensure this is not lost. If you have not yet applied for protection, then this is still possible as Individual Protection 2016 and Fixed Protection 2016 are still available where you’re eligible and can offer a protected LTA of up to £1.25 million.
For fixed protection 2016, the LTA was protected at £1.25 million and as with the previous versions of fixed protections, no further accrual or making of contributions was permitted after 5 April 2016 without the loss of the protection.
Individual protection 2016 protects the value of funds from £1 million up to a maximum of £1.25 million, valued as at 5 April 2016 but still allows contributions to be made.
Both forms of protection are only available for election online at the HMRC website. There is no planned end date to the election window.
Even for those with existing funds some way from this limit, investment growth over time could mean the limit is breached. Your financial planner will be able to undertake a headroom check to predict at what point you may breach the lifetime allowance and also whether it’s still worthwhile making contributions.
The LTA is a complex area requiring the specialist advice we are able to provide as the tax traps for the unwary could be very painful.
The annual allowance sets the limit on the total amount of tax relieved savings that can be made by or on behalf of an individual in each tax year. The standard annual allowance has been £40,000 since 2014/15 and was unchanged in the last budget.
From tax year 2016/17, the annual allowance fell further for very high earners, with the introduction of the tapered annual allowance. From 2021/22, this reduces the individual’s annual allowance by £1 for every £2 of ‘adjusted income’ over £240,000. The calculation is complex and, if you’re a high earner, you should take advice.
This means that for someone with an income of over £312,000, their annual allowance will be restricted to a maximum of just £4,000. Interestingly, a child is able to receive a pension contribution of up to £3,600. A sign perhaps that the pension rules need to change.
Third Party Contributions
The payment of contributions is not limited to an individual or employer; other people can also make contributions on the individual’s behalf.
These contributions are treated as if they’re paid by the individual with the limits that apply to their individual contributions. So, tax relief is restricted to the higher of £3,600 or their UK earnings.
These contributions are often made for children or grandchildren. If they’re young, this means that tax relief will be restricted to contributions of £3,600 gross per year. But for those that are working the (grand) child can also claim higher rates of tax relief if they’re a higher rate taxpayer.
Such pension contributions are a very effective way to help the family save for the very long term.