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Tax changes: How efficient investing can limit your liabilities
On March 23, Chancellor Rishi Sunak presented his Spring Statement in the House of Commons.
Not typically a platform for the introduction of major changes, this year’s announcement was slightly different thanks to the financial undercurrents swirling around the UK economy – including an estimated £410bn legacy from government measures taken to tackle the pandemic.
Back in March, barely a month into the war in Ukraine, households were already being hit by spiralling costs for energy, fuel and other items. Inflation had just increased to 6.2% and was building momentum towards its current level of 9% – the highest it has been for 40 years.
The Chancellor’s announcement outlined several changes, including confirmation of the previously announced 1.25% rise in National Insurance Contributions in the form of the Health and Social Care Levy. A number of other rates and thresholds were left untouched. The net result was that millions were left facing up to the duality of an increased tax burden from April as well as a squeeze on their wealth in real terms because of inflationary pressures.
Here, we look at some of those key changes and the steps you can take from a tax-planning perspective to maximise available reliefs and reduce your liabilities.
Rates on the rise for NICs and dividend tax
Further to the 1.25% rate rise, the Sprint Statement also included a change to the annual income thresholds at which National Insurance becomes payable. This was lifted to £9,880 from April and will be raised again to £12,570 from July, bringing it in line with the personal allowance. Annual earnings between the threshold level and up to £50,270 will now be subject to National Insurance Contributions (NICs) at a rate of 13.25% and annual earnings above £50,270 will be subject to NICs at a rate of 3.25%.
Further to the National insurance changes, April also ushered in an increase of 1.25% in the tax rates for earnings from dividends. As a result, dividend tax rates now stand at 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional-rate taxpayers.
Remember, these rates do not apply to the first £2,000 in dividend income, which is free from tax. However, anything over this amount will be subject to the new higher rates, impacting on earnings from privately held shares in listed companies or any dividend income paid to self-employed company directors.
Accessing the available tax-efficient allowances
In the context of such increases, taking advantage of the available mechanisms for tax-efficient investing becomes all the more important to protect your wealth and reduce the impact of any additional liabilities. For example, the savings allowances afforded to individuals within each tax year provide helpful and accessible routes to support financial planning over the longer term.
This includes the ability to invest in an Individual Savings Account (ISA), which comes in four forms: a cash ISA, a stocks and shares ISA, an innovative finance ISA or a Lifetime ISA. Individuals can pay in up to a maximum of £20,000 (for the 2022/23 financial year) across some or all types, and any interest or income generated will be free from income or Capital Gains Tax (CGT).
There are more restrictions associated with a Lifetime ISA, which is designed to support younger investors buying their own home or saving for later life. As such, applications are limited to those aged between 18 and 40, and the annual investment limit is £4,000 – which can form part of your overall £20,000 annual ISA total – with the government adding a 25% bonus to your savings of up to £1,000 per year.
Innovative finance ISAs are a slightly different again, as they provide a vehicle for investing in people or businesses on a peer-to-peer basis in the form of loans or by acquiring debt. The nature of this proposition means they carry a relatively high risk, exposing investors to the possibility that a borrower will default, and leaving them with no protection from the Financial Services Compensation Scheme (FSCS).
Pensions: A tax-friendly, long-term savings option
In tandem with ISAs, pensions can also form an important part of a tax-efficient investing strategy for the long term. Individuals typically benefit from an annual allowance of £40,000 that can be invested for later life free from income tax and CGT.
When paying into a pension, your money attracts tax relief from the government according to your income tax bracket, and when drawing down your pension, 25% of your fund can be taken tax-free while the remainder will be subject to tax.
The Pension Lifetime Allowance sets the limit for the amount that an individual can save throughout their lifetime. If this level is exceeded, pension benefits are taxed at an additional rate. Although it was previously much higher and also linked to inflation, this allowance is now capped at £1,073,100, and the Chancellor announced in 2021 that it will remain frozen at this level until 2025/2026.
This situation means that increasing numbers of people are expected to be at risk of breaching the lifetime allowance limit and facing the prospect of being issued with a tax bill on retirement. In light of rising inflation, the value of their savings will also be compromised in real terms.
Breaching the threshold can be avoided by diverting funds into tax-free savings vehicles such as ISAs, with a maximum annual allowance of £20,000 available. However, decisions such as this should be made ‘in the round’, as pension payments reduce your overall taxable income – sometimes, helpfully, below certain thresholds – whereas payments into ISAs are made after tax.
Clearly, there are many elements to consider. But at a time of having to absorb tax rises and adjust to a cost-of-living crisis, taking advantage of all the tax-efficient options at your disposal can provide some relief for your wealth.
The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Vintage Wealth Management or its associated representative shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.
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