New research reveals consumers are paying more than is necessary
RECENT Unbiased and TaxCalc figures have revealed that consumers are set to pay an unnecessary £4.6bn to the taxman this year by not using the allowances available to them. Despite this, 68 per cent admitted to doing nothing to reduce the amount of tax they pay. While no-one wants to give away more hard-earned cash than they need to, people are failing to make the effort to make their finances tax efficient. So what are the options?
As one of the most tax efficient ways of saving, a pension offers generous tax relief on what you put in. Investments within the pension grow free of capital gains and income tax, and the amount you can contribute tax free is linked to your earnings. When you make a pension contribution, 20 per cent basic tax relief is automatically added. And if you pay tax at higher or additional rates, you can claim back even more through your tax return.
And beyond simply using the pension tax wrapper, if you are part of a couple, you can tailor your contributions to make the most of tax free allowances. You may find that “pension contributions should go in the higher earner’s name to get a bigger tax relief, and taxable investments – like money in the bank – should go to the lower earner’s name to minimise the tax paid on it,” suggests Jason Witcombe of Evolve Financial Planners.
Over 4m adults are not contributing to a pension but are considering it. The time has come to take action: in December last year, the chancellor announced pension changes (taking effect from 2014-15), with a drop in the annual tax free allowance from £50,000 to £40,000 and in the lifetime allowance from £1.5m to £1.25m. A further reason to act now is the carry forward rule. If, during the past three years, you didn’t use up your allowance in full, you can carry over your leftover tax relief into the current tax year without incurring a charge. But the system operates on a rolling basis, so any unused tax relief from 2009-10 will be lost if not used by 5 April.
And the potential for gains doesn’t stop there. Financial experts point to Isas as the first port-of-call for savers and investors looking to shelter money from the taxman. But Unbiased found that savers are set to lose out on a combined £1.4bn this year by not appropriately using their Isas. With the end of the tax year rapidly approaching, there is still time for investors to shelter up to £11,280 in a stocks and shares Isa. The cash Isa limit is lower at £5,640.
And it may be a subject most prefer to avoid, but taxpayers are failing to place their life insurance policies in a trust. By doing so, investors can prevent the policy counting towards their taxable estate, meaning the insurance will specifically be paid to their heirs after death. Christopher Groves of Withers also recommends looking at purchasing assets which are exempt from inheritance tax, like farmland, woodland, and unquoted or Aim-quoted trading companies.
THINKING OUTSIDE THE BOX
While the above offer good tax-efficient homes for your cash, there are other ways to shelter your investments from tax. A venture capital trust (a quoted investment trust that invests in relatively small trading companies) is a good example. Income tax relief of 30 per cent is available on an investment of up to £200,000, and gains become exempt from capital gains tax once the investment has been held for five years. With recent changes to pension tax relief and increases to capital gains tax for higher earners, this may be an appealing option. Although a venture capital trust is a higher risk option, deterring some investors, it will “at least invest in several companies at once, so the risk is diversified”, says Tim Gregory of Saffrey Champness. Also be aware that income tax relief can only be claimed if you subscribe for new shares, and not for shares acquired on the secondary market.
The government has recently adopted new approaches to support fledgling companies. The Enterprise Investment Scheme (EIS), for example, is designed to enable smaller high-risk trading companies to raise finance by offering a range of tax reliefs – including exemption from capital gains tax and inheritance tax – to investors who purchase new shares in those companies. The EIS gives investors 30 per cent income tax relief on an investment of up to £1m in 2012-13. But investors must hold the EIS shares for a minimum three years, making them quite inflexible.
The Seed Enterprise Investment Scheme (SEIS) is a smaller version of EIS, offering an even larger tax break of 50 per cent on any capital gains on an investment of up to £100,000. A key advantage is that, if you use a gain from the sale of something else, “the amount you invest in SEIS will be exempt from capital gains tax – whereas with EIS it is just deferred,” says Gregory. However, as with EIS, the scheme’s companies are not listed on the main stock exchange – potentially a riskier option. But the government does offer up to 50 per cent loss relief on any holding that falls in value. It’s not entirely clear how long SEIS will run, however, so it’s important to take advantage as soon as possible.
And if you are a business owner looking to sell your company, it may be worth investigating whether you qualify for Entrepreneurs’s Relief, which limits the capital gains tax rate to 10 per cent for the first lifetime gains of £10m. If a spouse or partner also owns part of the business, “they may be able to use their own lifetime £10m limit so that the sale of the business can generate a profit of up to £20m that is taxed at only 10 per cent,” says Gregory.