Despite some high profile cases of tax avoidance, it remains a Government objective to encourage saving by providing legitimate ways of minimising tax. The end of the tax year is the ideal time to consider some of the opportunities.
Inheritance tax can be reduced by transferring the assets on which the tax is charged, so as to reduce the value of an estate. Transfers between spouses and civil partners are exempt where the recipient is domiciled in the UK, and two main exemptions are available for other transfers, namely the annual exemption of £3,000 and the small gifts exemption, which permits gifts of up to of £250 to be made to any number of individuals each tax year with no liability to inheritance tax.
Larger gifts can be made without triggering any IHT consequences if the donor is able to demonstrate that these are made on a regular basis out of current income without affecting the donor’s standard of living. There is no limit to the sums that can be gifted, provided that the payments are made from income rather than capital. Such gifts could be used to fund a pension scheme for a child or grandchild, and for a non-tax-paying recipient a pension contribution of £2,880 would be topped-up by the taxman to £3,600.
Income tax. All taxpayers are exempt from income tax on an initial slice of income covered by their personal allowance and are taxed at the basic rate on the next tier of income. The personal allowance is based on ‘adjusted net income’, which is defined as taxable income after deducting allowable losses, less the gross amount of any pension contributions and gift aid donations.
If an individual’s adjusted net income exceeds £100,000 p.a., the standard personal allowance is reduced by £1 for every £2 of the excess; and similar reductions apply to age-related allowances for those aged over 65 whose adjusted net income exceeds £24,000.
It pays, therefore, to minimise adjusted net income by, for example, transferring income-producing assets from a higher tax-paying spouse to a lower tax-paying partner or by making pension contributions.
There are suggestions that the Chancellor might reduce the contribution limits for pensions, but currently taxpayers can contribute up to the value of their earnings, subject to a maximum of £50,000 p.a., so early action might be required.
Capital Gains Tax is charged at only 18%, or 28% for higher-rate taxpayers, compared with income tax at 40% or 50%. Nevertheless it makes sense to take advantage of the CGT exemption of £10,600 to which all taxpayers are entitled in the current tax year and 2012/13. This is a “use it or lose it” concession which cannot be carried forward from one tax year to the next. So it may be worth crystallising gains from the recently buoyant stock market before 6 April.
Unfortunately, it is no longer possible to crystallise gains by selling and then immediately re-purchasing an investment – so-called “bed and breakfasting” – though similar results can be achieved, albeit at additional cost, by arranging re-purchase by a spouse or via an ISA or Personal Pension.
As between spouses, transfers of assets can be made without crystallising gains or losses, which permits couples to equalise their assets so that both can realise gains up to the level of the exemption.
When a loss has been crystallised, it will be offset against gains which have been realised in the same tax year and any excess can be carried forward to set against gains in future tax years. However, losses must be claimed, usually via the self-assessment tax return, within four years of the end of the tax year in which the loss is crystallised.
The lower tax rate applicable to capital gains, compared with income, may suggest a bias towards growth rather than income investments and towards those types of investment wrapper, such as unit trusts and shares, where most of the profit will be taxed by CGT. Clearly, however, the question of minimising tax on investments should only arise after full use has been made of the annual entitlement to invest in tax-free ISAs, which currently stands at £10,680.
Investing in turbulent times
The gyrations of markets in investments, property and other assets since the on-set of the financial crisis in 2008 have thrown up a number of conclusions;
- The scare over the security of banks has subsided and cash has provided a safe haven for many, but its value is being eroded by inflation and cash is not a sensible long-term investment.
- Passive investments such as tracker funds and Exchange Traded Funds carry lower charges than managed investments and may have a role to play in portfolios, particularly at times when markets are depressed.
- Increasing longevity and the removal of the requirement that pension investments must be crystallised at age 75 means that investors should be able to maintain some exposure to risk assets for longer periods of time.