New allowances from April will benefit many savers, inheritors and pensioners – provided you act now.
A year-end tax review is always useful to ensure that you do not lose out on allowances and incentives. This year, however, it is imperative, following a series of changes in tax and inheritance legislation that has thrown up a range of opportunities to make savings, both now and in the future, if you act before 6 April.
Perhaps the most significant opportunity arises from the interaction between changes to the Inheritance Tax (IHT) rules on pensions, which were introduced last April, and the reduction in the annual allowance for pension contributions for some higher earners, which takes effect this April.
The changes to IHT mean that, with some exceptions, pension funds can now be passed on tax-free by those who die under the age of 75. If the person dies at or after the age of 75, then the pension will, in many situations, be subject only to Income Tax in the hands of the heir, who can continue to receive money from the fund for as long as it lasts.
Tony Müdd, Divisional Director, Development and Technical Consultancy at St. James’s Place, says the changes to the way pensions are taxed on death will have a big impact on estate planning: ‘This will become an important part of someone’s Inheritance Tax planning.’
Pension tax incentives for higher earners are being reduced from 6 April so that the maximum tax-free contribution for those earning more than £150,000 will gradually be reduced from £40,000 to as low as £10,000 for those most affected. Unused annual allowances can be carried forward for three years. Thus, those who will be affected by the change should consider making the most of unused contributions before the new limits kick in.
Dividend taxation is being changed with the introduction on 6 April, of a nil rate on the first £5,000 a year from Income Tax. Receipts above that level will be subject to 7.5%, 32.5% or 38.1% tax, depending on whether your income is subject to the basic, higher or additional rate. Those with dividend earnings above the threshold should, therefore, consider changing the balance of dividend income. This could be done, for example, by switching investments between spouses or, for business owners, adjusting the balance between salary and dividend income. ‘It’s very much a bespoke decision for each individual,’ says Müdd.
Another new tax incentive is the Personal Savings Allowance – again, starting on 6 April – which offers a tax break on up to £1,000 of bank and building society interest for basic rate taxpayers (or up to £500 for higher rate taxpayers). Tax will no longer be deducted at source from these accounts.
‘The introduction of these new measures will encourage many couples to redistribute assets between them to ensure that their joint arrangements are as effective as possible,’ says Müdd. So a husband who has £10,000 of dividend income might give half of the underlying shareholding to his wife so that both spouses fall within the Dividend Allowance. Similar steps can be taken with the Personal Savings Allowance and couples could also help each other to use up their pension contribution allowances.
The usual year-end checks are also still important. These include using the annual £3,000 gift allowance and £250 small gifts exemption in IHT planning. ISAs can also now be a useful tool in IHT planning, following changes that came into effect in April last year. These allow individuals to pass ISA holdings onto a spouse or civil partner, thereby preserving the tax relief. The ISA tax wrapper protects the value, and any future growth from them, for the remainder of the life of the inheriting spouse or civil partner – one more reason to ensure that you make the most of the annual ISA allowance – of £15,240 per person – this tax year.
Getting on top of all these changes now is a good move because there is another major change coming down the line that will also require some planning by homeowners.
The new residential nil-rate band (RNRB) starts in April 2017 at a level of £100,000 and will increase by £25,000 a year, finally reaching £175,000 in April 2020.
‘This will take a lot of people out of the IHT net,’ says Tony Müdd. The RNRB protects the home from IHT in cases where that property is passed on to a direct descendant. Unused RNRB can be passed on to a surviving spouse or civil partner. RNRB is of most use to people with homes worth up to £2 million. For homes with higher valuations, the RNRB is tapered away.
It is particularly important for people with Wills to review these changes in order to adapt them to the new fiscal environment.
The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.