Each year the government allows certain limited investments and transactions to be made tax-free. This year’s tax allowances and exemptions expire on 5 April 2018. Doctors who haven’t used this year’s allowances have only a few weeks remaining if they wish to take advantage.
Probably the best known allowance is the ISA allowance. This is £20,000 and can be split in any proportion between cash, stocks and shares and innovative finance ISAs. Under 40s also have the option to put up to £4,000 of the allowance in a Lifetime ISA.
Once in an ISA your money grows free of income tax and capital gains tax. It can then be withdrawn tax-free at any time. By using the ISA allowance each year it’s possible to build up a significant amount in tax-free savings and investments – there are ISA millionaires out there!
The Capital Gains Tax exemption is £11,300 for 2017/18. This means capital gains of up to £11,300 can be taken tax-free before the end of the tax year. If you have a portfolio that’s showing gains it can be a good idea to rebalance to take some profits and make use of the Capital Gains Tax exemption. Taking gains gradually over time in this way can help avoid the Capital Gains Tax bill that might otherwise occur if the full gain was realised in one go.
Normally gifts are only considered outside of your estate (and hence Inheritance Tax-free) if you survive for at least seven years after making them. However, there is an annual exemption that allows you to gift up to £3,000 a year to anyone you choose. Gifts made under the annual exemption are immediately outside of your estate and IHT-free. If you have an Inheritance Tax liability (estates of £325,000+ including the value of your home may be affected) the earlier you start gifting the more you will be able to pass on IHT-free under this exemption over the years.
The annual exemption can be carried forward for one year so if unused last year it is possible to gift up to £6,000 IHT-free before the end of this tax year.
Each tax year an individual can receive income tax relief on pension contributions up to the value of their earnings. Basic rate relief at 20% is added automatically and higher and additional rate taxpayers can claim a further 20% and 25% respectively through their tax return. Once in a pension your money grows free of income tax and capital gains tax.
There are, however, a couple of points to watch out for. Firstly, pension funds cannot be accessed until minimum pension age (currently 55, increasing to 57 in 2028). 25% can be taken tax-free and the rest will be taxable. Secondly, pension contributions are also effectively limited by the Annual Allowance. This is £40,000 for most people but reduces to as little as £10,000 for higher earners (earning £150,000+) or £4,000 for anyone who has already flexibly accessed pension benefits. Contributions in excess of the Annual Allowance attract a tax charge at your marginal rate of income tax (i.e. 20% for basic rate, 40% for higher rate and 45% for additional rate taxpayers).
Both personal and employer pension contributions count towards the Annual Allowance, as well as the accrual of benefits in final salary pensions such as the NHS Pension. Doctors who are members of the NHS Pension Scheme should always check how much Annual Allowance they have remaining, if any, before making further pension contributions.
To incentivise investment in very small UK companies the government offers generous tax breaks for investing in Venture Capital Trusts (VCTs). These are companies whose business is to invest in other small businesses, providing them with capital to hopefully grow and become the bigger companies of tomorrow. However, this area of investment is very high risk as many businesses in their early stages will go on to fail. VCTs invest in a number of businesses (usually around 20+) with the aim that the performance of successful companies will more than make up for those that fail, although this of course is not guaranteed.
For those who are interested in investing in very small companies and can accept the associated investment risk, the tax benefits are income tax relief at 30%, tax-free dividends and no capital gains tax on disposal. The maximum investment each tax year is £200,000 meaning theoretically it is possible to claim £60,000 income tax relief, but only if you have paid income tax of £60,000 or more as tax relief is limited to the amount of income tax you pay.
Note VCTs are long term investments and must be held for at least five years in order to retain the tax relief. They would ideally be held for ten years plus to take advantage of the tax-free dividends paid as the portfolio matures.
Due to their high risk nature, VCTs would usually only be considered by sophisticated investors who have already used their ISA and pension allowances. The Financial Conduct Authority (FCA) defines a sophisticated investor as somebody with income of £100,000+ and/or investable assets of £250,000+. However, even for these individuals suitability will also depend on other factors so we recommend getting financial advice if you are interested in VCTs.
The Lifetime Allowance for pension benefits is increasing from £1,000,000 to £1,030,000 on 6 April 2018. The advantage of waiting until after 5 April 2018 to take pension benefits is obvious for an individual with a pension worth £1,020,000 for instance: a 55% tax charge on the £20,000 excess if taken on 5 April 2018, or no tax charge if taken on 6 April 2018.
However, even those not at the threshold will benefit by waiting until after 5 April if this otherwise suits their circumstances as they will use up a smaller proportion of the Lifetime Allowance. For example, a £650,000 pension will use up 63% of the Lifetime Allowance from 6 April 2018 instead of 65%. The distinction might seem small but could make the difference between paying a Lifetime Allowance Charge or not when taking further benefits in the future or at the ‘age 75’ test (where the growth on drawdown pension funds is tested against the Lifetime Allowance at age 75). With the Lifetime Allowance set to continue rising in line with inflation, an extra 2% unused allowance could equate to tens of thousands of pounds more available Lifetime Allowance in future.
Please note the value of tax benefits depends on individual circumstances and tax rules are subject to change by the government. This article does not constitute personal financial advice. If you would like advice on investing tax-efficiently please contact Richard Higgs CFP FPFS on 0117 966 5699 or firstname.lastname@example.org.