Boost savings by actively using your allowances

Last updated 13 March 2018

The tax year end is an opportunity for clients to boost their savings by making the most of annual tax breaks. Any allowances that would otherwise remain unused, such as the CGT exemption or personal allowance, are a chance to take investment profits 'tax free' from OEICs and bonds. If not used in this way by the 6th April, they will be lost forever.

This years' CGT allowance of £11,300 could save a higher rate taxpayer £2,260. Put another way, failure to use it could ultimately cost them £2,260. And allowing gains to accumulate could cost similar amounts each year they do not use their allowance. So even though a client may not need the proceeds, taking the gains may still be the rational thing to do.

Taking bond gains tax free may be slightly trickier, as gains are subject to income tax, which means to benefit from a 0% rate requires a client to have low income levels. If your client is not this person, then an assignment to someone who is, such as a spouse, may be an option.

The re-investment options

Having taken profits tax free, consideration then needs to be given towards re-investment of the proceeds. SIPPs and ISAs are the most tax efficient for those who have scope. Both have automatic protection from income tax and capital gains tax on funds invested.

In contrast, a personal portfolio of OEICs/unit trusts are not protected. Income in excess of the dividend allowance will be taxed when it arises, and there is a greater possibility of this next year when the allowance drops to £2,000. And capital gains will be taxed if they exceed the annual CGT allowance, currently £11,300.

Offshore bonds do protect funds from further tax during the investment period, but unlike ISAs, this is only a deferral of tax.

Remember that clients holding onshore bonds will always be suffering some tax on their investment returns. Credit is given at basic rate on these plans on surrender to reflect the tax already deducted. So while funds cannot be extracted tax free using allowances there may be no further liability provided the top sliced gain doesn't push clients into higher rate tax.

Why SIPPs and ISAs?

Given that offshore bonds and a personal portfolio of OEICs have the potential to be taxed, then ISAs are a logical choice for the certainty they offer (ignoring charges), provided clients have enough subscription limit available.

But put ISAs in a head to head with SIPP, and if retirement saving is the goal, it is the special tax treatment of SIPPs that normally wins the day.

Consider a lump sum of £20k allocated for saving by a higher rate taxpayer, who will be a basic rate taxpayer when they take their money. Ignoring growth (as investment growth is taxed in the same way under both SIPP and ISA), the outcome is:

	ISA	SIPP
Initial cost of investment	£20,000	£20,000
Amount invested in wrapper	£20,000	£33,333
Amount withdrawn after tax	£20,000	£28,333

As there is no further tax on investments held within ISA or SIPP, the 41% difference is purely down to the tax treatment of the SIPP. Specifically that a higher rate taxpayer gets 40% tax relief on money saved into a SIPP, and when money is withdrawn, 25% is tax free. And this also works for a client who will always be a basic taxpayer, who would see a return after tax of £21,250. A little more complicated maybe compared to an ISA which simply protects investments from tax, but only a little!

Clearly a tax year-end review of allowances still available and using them to take profits and recycle into the best available tax wrapper year on year can really make a client's lifetime savings work harder. The following example shows how this may look:

Example

Jenny purchased a portfolio of unit trusts with an inheritance she received some years ago. She has earmarked this for her retirement, and it is now worth £200,000.

Any capital gains arising during the investment period have been due to a rebalancing of her funds, and have always been well within her annual CGT exemption. She decides to engage a financial adviser to see if her savings are in the right place.

The adviser determines the following:

Financial facts:

Jenny is 54 and a higher rate taxpayer (net income of £75,000)
Capital gains realised on trades this year are £1,300
Her total pension contributions for the year are £10,000, including £5,000 from her employer
She currently has no pension annual allowance to carry forward
She has saved £4,000 into her ISA this year

Scope – unused allowances:

CGT allowance £10,000
ISA allowance £16,000
Pension annual allowance £30,000

Advice:

Realise £10,000 of capital gain from the unit trusts
Unit trusts to the value of £40,000 have been selected to achieve this
Pay a gross pension contribution of £30,000 at a cost of £24,000 (after basic rate tax relief at source)
Use the remaining £16,000 to maximise her ISA allowance for the year

Benefits to Jenny:

Potential CGT saving up to £2,000. Profits have been taken from her unit trust portfolio free of tax. Left invested, they could have cost her £1,000 to £2,000 in extra tax when eventually taken (depending on her level of income at that time).
Extra £6,000 in spendable income. Spendable income has increased because her higher rate threshold is boosted by the pension contribution to £75,000. This means she does not pay higher rate tax on any of her income. If not spent, this could also be saved.
Increased total savings of £6,000.* Total savings have increased because of tax relief given at source on the pension contribution.
Tax free growth. Investment returns are protected from income tax and capital gains tax on the new money in the pension and ISA.
Bigger potential inheritance for family. Pension also offers protection from IHT. Beneficiaries will pay no tax on death before age 75. Withdrawals of death benefits after this age will be subject to income tax at beneficiaries rate, but can be managed over time to reduce impact.
Retain favourite investments. She can re-invest back into same unit trusts if she wants to (provided available on relevant investment platform) because she would be buying back through her pension and ISA wrappers, so the share matching rules don't apply – gain stays

* These may be taxed when taken from pension, but 25% tax free cash available for funds below LTA.

Based on main UK rates and allowances - different tax rates and bands apply in Scotland.

The family unit

As already touched on, a client may also wish to make the most of any unused allowances of their partner.

OEICs / unit trusts can be transferred to a spouse or civil partner without any tax so that partner can cash in using their own annual CGT allowance.

The same can be achieved with the assignment of bonds as 'gifts' are not chargeable events.

Summary

Making the most of the annual tax breaks on offer is a great way to demonstrate the value of advice. The amount of tax saved can be measured, and while these savings may seem relatively small, if done every year can make a significant difference to savings.