Capital gains
Everyone can make investment gains of £10,100 each year without having to pay capital gains tax (CGT). Utilising this allowance in full each year results in a £1,818 saving for non- and basic-rate taxpayers and a £2,828 saving for higher- and additional-rate taxpayers. Remember though that CGT applies when you make a profit from all sorts of other assets (including for example second homes, and most belongings which appreciate in value) so plan carefully when you realise these gains to make the most of the annual allowances.
Pensions
Money invested into a pension receives tax relief. Put simply, that means your pension contributions (subject to limits set by the Government) are increased by the percentage amount of your income tax bracket. So, a non- or a basic-rate taxpayer only has to pay 80 pence for each £1 that is invested in their pension (an uplift of 20%). Higher-rate taxpayers effectively only pay 60 pence for each £1 invested (an uplift of 40%) and additional-rate taxpayers (in the 50% band) can benefit from 50% relief.
Non-working individuals can invest up to £3,600 in a pension each year, but because of the tax reliefTax reliefAmounts which you can deduct from your annual income to reduce the amount on which you have to pay tax. For instance, if your income before deduction of reliefs is £20,000, and you made pension contributions in the year of £1,000, you could deduct £1,000 from £20,000 to produce a total income for tax purposes of £19,000. That is because pension contributions are payments on which HM Revenue & Customs allows tax relief. this will only cost £2,880. Adults can also make such payments for children.
People who have taxable income in excess of £100,000 have their personal annual tax allowance reduced at a rate of £1 for every £2 of income over this threshold. This effectively results in the creation of a 60% tax band for those with income between £100,000 and £112,950. This can be avoided if sufficient pension contributions can be made to bring income below the £100,000 threshold.
Of course, the benefits of pension saving are not immediate, and you have to wait until you are at least 55 before you can reap the rewards of a tax-free lump sum and taxable income. Currently 25% of your pension fund can be taken as a lump sum.
Other investments
People with high earnings and who are likely to be higher rate taxpayers in retirement, or who have restricted pension funding options and have used all of their other annual tax allowances, could consider other tax-efficient investments such as a Maximum Investment Plan. These types of plans (known also as qualifying policies) mean any growth from the investments will be free from any personal higher- and additional-rate income tax and CGT when cashed in as long as regular investments are maintained for at least 10 years. Withdrawals after the 10 year period will not be liable to any additional tax either. Note that the underlying funds invested in will suffer life fund taxation at a rate around 20%.
Higher- and additional-rate taxpayers can also use onshore investment bonds to enable tax to be deferred on income and gains until a time when they might be taxed in a lower rate.
Phil Carroll is Financial Planning Manager at Skandia.
Everyone’s tax situation is different and the value of any tax relief will depend on your own individual circumstances.