Tax changes (or not!) on the horizon
Once we get to April, the stealth tax proposals announced by the Government in their two Budgets in 2021 will start to be felt with full effect.
As a reminder:
- the income tax personal allowance will be frozen at £12,570 until tax year 2025/26.
- the income tax higher rate tax threshold will be frozen at £50,270 until tax year 2025/26; and
- the CGT annual exempt amount will be frozen at £12,300 until 2025/26.
It is estimated that the freezing of the income tax personal allowance and higher rate tax threshold will cause more than a million people to fall into higher rate income tax over this period. You are very likely to have clients who will be affected.
NICs and dividend tax
In just under 3 months (with effect from 6 April 2022), Class 1 and 4 National Insurance contribution (NIC) rates will increase by 1.25%. In April 2023, this NIC increase will be replaced by the Health and Social Care Levy. This increase will apply to:
- employers; and
- the self employed.
More than 29 million workers will be affected and means that someone earning £30,000 per year will pay £255 more per annum and someone earning £50,000 paying £505 per annum more.
The tax rates on dividends will also increase by 1.25% and this will affect people who run small businesses via a company and draw dividends as remuneration as well as people who are investors who hold shares directly.
Planning action to consider
By taking suitable planning action, clients can take the sting out of some of these forthcoming tax increases.
Here are some planning ideas:
Pensions and tax relief
People making contributions to registered pension plans qualify for income tax relief at their marginal rate. Therefore, for those clients who move into higher rate tax because of the stealth tax provisions, a contribution to a personal pension plan will be even more attractive because the basic rate tax band will be extended. Despite previous rumours that the Government may act to restrict higher rate tax relief on pension contributions to date, no action has so far been announced.
However, given the tax revenue at stake (in the order of £40bn), this is definitely an area that the Government will keep under review. But, equally, it is also an area that has complications – especially in terms of restricting tax relief for those who are members of defined benefit schemes or are one of the army of people who now pay pension contributions to auto-enrolment schemes.
In these circumstances, we would suggest that, if a client
- is a higher rate taxpayer;
- has not used all of his or her pensions annual allowances; and
- has “spare” money available that is not earmarked for other expenditure,
now might be the time to make additional pension contributions.
And, in this respect, remember that if a client has not utilised his or her full £40,000 annual allowance in each of the last 3 years, unused relief will be available to carry forward. This means that, if a full contribution is paid in this year (and subject to it not exceeding the client’s relevant earnings), it may be possible to make a contribution in respect of some, or all, of this unused relief. This, of course, assumes that the client’s allowances have not been restricted because he has income of more than £210,000 or has already drawn pension benefits.
So, for those higher or additional rate taxpayers who have previously put a pension contribution review on the shelf, now might be a time to act.
If higher rate taxpaying clients have available pension allowances and fear that pensions tax relief might be reduced, they should act quickly before any changes are announced.
Pensions as a part of other financial planning
As well as being a highly tax efficient investment in its own right, a pension contribution can also assist people to achieve a whole range of other tax planning solutions, as follows:
- Child Benefit
Where a single parent, or one of a couple, who is entitled to claim Child Benefit has adjusted net income (ANI) that exceeds £50,000, they will suffer a High Income Child Benefit (HICB) charge. This will, in effect, slowly neutralise the Child Benefit. With an ANI of £60,000, or more, all of the Child Benefit received is effectively clawed back through the HICB charge.
The £50,000 threshold was introduced in 2013 and has never been increased – another good example of stealth tax. This means that more and more people have been caught by the HICB charge. For such people, the payment of a pension contribution can reduce adjusted net income and so, in the right circumstances, reduce the impact of the HICB charge. For a practical example of how this planning can work see here.
- People who pay income tax at 60%
Yes, 60%. It is a fact that those people who have adjusted net income (ANI) that causes them to lose their personal allowance will suffer income tax at 60% on a slice of their income - 40% as a higher rate taxpayer and a further 20% because each £1 of adjusted net income in the £100,000 to £125,140 band causes a loss of 50p in the personal allowance. This means that income in that band is taxed more heavily. When ANI reaches £125,140, all of the personal allowance is lost. This £100,000 threshold has not been increased for years and, because the personal allowance is currently frozen, more and more people will start to lose all of their personal allowance because their adjusted net income exceeds £125,140.
One easy solution to this problem which can apply in the right circumstances is to make a member contribution to a registered pension plan. This is because the gross contribution reduces ANI and, if this reduction occurs in the band £100,000 to £125,140, 60% income tax relief is available.
For an example of how the payment of a pension contribution can help those whose income causes them to lose their personal allowance see here.
(c) National Insurance hikes and salary sacrifice
As we state above, employer and employee NIC rates will increase by 1.25% from 6 April 2022.
For those employees who are interested in making pension provision and wish to reduce the impact of the increase of NICs, salary (and bonus) sacrifice will become even more attractive.
The idea here is that the employee gives up some of his earnings in return for the employer paying this into a pension plan. This will save the employer NICs. Some employers may be willing to contribute all or a part of their NIC saving on the sacrificed salary meaning even more is paid into the pension plan. For an example of practical planning using salary sacrifice (and some of the other issues that need to be considered) see here.
(d) Taxable capital gains or chargeable event gains on life policies
In general, the way that tax relief is given on contributions to a personal pension plan is for the payment to be made net of basic rate tax relief (“relief at source”). Any higher rate tax relief is then given by extending the taxpayer’s basic rate income tax band so that more of his or her other income falls into basic rate income tax rather than being subject to higher rate. This can be extremely useful for clients who are encashing life assurance policies and who wish to reduce the income tax they pay on those gains or clients who have a capital gain that causes them to exceed their CGT annual exempt amount. This is particularly the case where the gain causes the person to move into higher rate tax.
For more details and an example of how a pension contribution might reduce income tax on the chargeable event gains from a single premium bond see here. For more details on how a pension contribution can reduce CGT on a capital gain from an investment see here.
This is just a summary of the financial planning ideas linked to the payment of pension contributions which we are happy to follow up on with you and your clients.
As we explained earlier, as well as the forthcoming increases in rates of NICs, dividend taxation is also increasing from April 2022. This is designed to prevent directors/shareholders getting more of an advantage if they withdraw cash from a private company by way of dividend rather than salary and bonus. But it also means that general investors will pay higher rates of tax on dividend income from their investment portfolios. So, from tax year 2022/23 onwards, where annual dividend income exceeds the dividend allowance of £2,000, it will be subject to income tax at 8.75% for any part that falls into the basic rate income tax band, 33.75% for any part that falls into the higher rate income tax band and 39.35% for any part that falls into the additional rate income tax band.
For those who enjoy taxable dividend income, what planning action should they take? Well, this will depend on whether they are business owners or investors.
Business owners are still likely to be better off drawing dividends as opposed to salary/ bonuses from a private limited company because of the NIC savings that will arise. However, where dividends are due to be drawn over the next 6 months or so, it may be better if this can be brought forward so that dividend income falls to be taxed in 2021/22 and before the 1.25% dividend tax increase takes place.
For those clients who are investors with taxable dividend income, it would make sense for them to consider reinvesting some of their investment capital into more tax efficient areas such as
- ISAs – no income tax on dividend income credited to the ISA account;
- VCTs –dividends paid to investors are tax-free; and
- SIPPs – no tax on dividend income arising within the pension wrapper.
Which will be appropriate will depend on the circumstances of the client. Please ask us for our recommendations for any particular client.
The CGT on the encashment of any investment to fund reinvestment would need to be considered but, at the very least, clients should seek to use their CGT annual exempt amount of £12,300. Gains in excess of this arising from the encashment of investments would be subject to a maximum rate of CGT of 20%.
Assets can be transferred between a married couple on a ‘no gain – no loss’ basis, potentially allowing both partners to maximise the use of their CGT annual exempt amounts in the future.
An investment in UK single premium bonds can also be attractive when the insurance unit linked funds are invested in UK equities. This is because the insurance company will not suffer corporation tax on dividend income (as it is treated as franked income) yet the investor will still get a credit for basic rate income tax when calculating income tax due on chargeable event gains that could arise when the policy is encashed.
It is important to remember that the recent changes on trust registration mean that most trusts - even those that are non-taxable - now need to be registered on HMRC’s Trust Registration Service. Certain exemptions do exist, one of which is for trusts of life policies that only pay out on the death, critical illness or ill health of the life assured. In this respect, HMRC has recently clarified that life policies that have a surrender value will be exempt from registration if the surrender will bring the policy to an end. Where part surrenders and/ or withdrawals can be made, the exemption from registration does not apply. This means that trusts holding life policies such as single premium bonds and capital redemption plans will not be excluded trusts and will need to be registered by 1 September 2022 (or within 90 days of the date the trust was created, if later).
For details of a competitive trust registration service that we have available see here.
High Income Child Benefit charge – Marie
Marie is single and has a 15-year old son called Jake.
Marie is entitled to Child Benefit of £1,100 per annum. However, because Marie’s adjusted net income is £51,000 per annum, she pays a High Income Child Benefit charge of £110. By making a net pension contribution of £800 (£1,000 gross) to a personal pension plan, she can reduce her adjusted net income to £50,000 and avoid the payment of any HICB charge. Marie will receive additional income tax relief of £146 (20% of £730) through removing £730 of her taxable income from the higher rate tax band.
Loss of personal allowance – Brian
Brian has adjusted net income of £102,000. This means that, as well as being taxed at 40%, £2,000 of his income is causing him to lose £1,000 of his personal allowance leaving him with a personal allowance of £11,570. The top £2,000 of income is therefore effectively being taxed at 60% and, if it is employment income, will be subject to a further 2% NIC charge (3.25% from April 2022). A personal pension contribution of £1,600 net (£2,000 gross) will reduce his adjusted net income to £100,000, reinstate his full personal allowance and effectively give him tax relief at 60% on the contribution.
Salary sacrifice – Jack
Jack has a salary of £30,000 in tax year 2022/23. On his top £1,000 of salary, he will pay £332.50 in income tax and employee NICs, leaving Jack with net income of £667.50 on this slice of his salary. Jack gives up £1,000 of salary in return for his employer making an additional contribution of this amount into his pension scheme. This will save his employer £150.50 in employer NICs which can also be paid to the pension scheme, making up to £1,150.50 in total. This is all at a net cost to him of £667.50 (the net income - after tax and NICs). Even if Jack’s employer decides not to add some or all of the employer NIC saving to Jack’s pension scheme, Jack has still received effective tax relief of 33.25%. If the employer adds all of the NIC saving, Jack’s effective tax relief is 41.98%.
Two words of warning on salary sacrifice:
given the proposed increase in NIC rates and the additional advantages of salary sacrifice, there may be a risk that the Government takes action to outlaw it in a forthcoming Budget – although there could be a chance that schemes set up before the Budget are not affected
salary sacrifice does reduce the net salary an employee receives and this can have important consequences in other areas which rely on multiples of salary say the entitlement to life assurance payments on death or the ability to borrow via mortgages. Also, of course, the employee should not be relying on the salary given up to maintain their standard of living.
Reducing income tax on chargeable event gains – Ingrid
When calculating income tax on UK life policy chargeable event gains, there is no personal tax charge on gains that fall within the basic rate tax band. So, the bigger the basic rate income tax band, the greater the chance of there being less (or no) tax on the bond encashment.
Ingrid has income of £41,270 (£1,000 of which is savings income) and realises a chargeable event gain of £30,000 under her UK investment bond which has been running for 3 years. This means that £1,000 of the top-sliced gain of £10,000 under the Bond falls into higher rate tax meaning a higher rate tax liability of £600 applies on the whole gain. By making a personal pension contribution of £800 (£1,000 gross), she can reduce her tax bill on the chargeable event gain to zero. The effective cost to Ingrid of the £1,000 gross pension contribution is then £200.
Reducing CGT on investments - Azim
A taxable capital gain (net gains less any annual exempt amount) suffers CGT at
10% to the extent it falls within the taxpayer’s basic rate income tax band; or
20% if it falls into a higher rate income tax band
when added to taxable income.
Higher rates (18%/ 28%) apply to gains linked to residential property.
So, the greater the basic rate income tax band, then, potentially, the lower the overall rate of CGT payable. The payment of a personal pension contribution can extend the basic rate income tax band.
Azim has a salary of £48,270. He sells shares in some quoted stocks and shares realising a capital gain of £16,300. Net of his CGT annual exempt amount of £12,300, this leaves a taxable gain of £4,000 – with CGT payable on £2,000 @ 10% and £2,000 @ 20%. This means there is a total CGT liability of £600. Alternatively, if he paid £1,600 net into a personal pension plan, this will stretch his basic rate income tax band by £2,000, meaning he will save CGT of £200. In effect, he gets 30% tax relief on the pension contribution.
The comments made above are for information purposes only and are based on Panoramic Wealth Management Ltd’s understanding of applicable legislation and current HMRC practice as at 1 January 2022.