As the new tax year is fast approaching attention is turning towards the increase in allowances that will be introduced, however, all is not as it seems. Despite the ‘positive’ news some individuals could actually be worse off.
The Personal Allowance (which is the amount you earn before starting to pay tax) is increasing from £11,500 to £11,850. This is good news as it will mean more earnings are tax free with the knock on effect that more of your earnings will be in the basic rate tax bracket. In addition, the annual Capital Gains Tax exemption (which is the amount of gain you can crystallise before paying tax on some investments) is increasing from £11,300 to £11,700. Again this is positive news as it means that more of your gains are tax free.
There is, however, some not so good news as the amount of dividends you can receive before paying tax is reducing form £5,000 to £2,000. For a basic rate tax payer this amounts to extra tax of £225 but for a higher rate tax payer the extra tax payable will be £975.
This means, the total ‘tax free’ allowances are reducing from £27,800 to £25,550 and therefore (for some) an increase in the amount of tax you need to pay. These figures show the importance of financial planning and ensuring that all your allowances are utilised in the most tax efficient manner.
There is also a further consideration which could increase further the amount of tax, this being the reduction in Personal Allowance if your earnings exceed £100,000. For every £2 worth of earnings over £100,000 your Personal Allowance is reduced by £1, for the current tax year this means if your earnings exceed £123,000 you will not have any Personal Allowance.
One solution, to reducing the amount of tax you pay could be to make a pension contribution. This has the impact of effectively reducing your earnings.
If your earnings are between £100,000 to £123,000 for the current tax year (or £123,700 for the 2017/2018), a pension contribution could mean that you retain your full Personal Allowance, effectively providing tax relief of 60%. Pensions are a fantastic financial planning tool, offering tax relief, tax free growth and flexibility of access when you reach your retirement age. In addition, with the assets generally being outside of your estate for Inheritance Tax purposes they are fantastic for estate planning.
However, I think it is fair to say that calculating the maximum you can pay in to a pension is not straight forward. The maximum you can contribute to a pension (known as the annual allowance), is ‘tapered’ (or reduced!) if your total earnings exceed £150,000, which adds a further layer of complication as you need to know your earnings for the current tax year. At Wingate, we are experts in dealing with these calculations and offering solutions to your financial planning needs. If you are considering making a pension contribution in the current tax year we would be delighted to help you, please do not hesitate to contact one of the financial planning team.