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Investment special: Tax allowances - use them or lose them

Tax-planning tips ahead of next month’s fiscal year-end

9 March 2013

9:00 AM

9 March 2013

9:00 AM

As if to demonstrate that every silver lining has a grey cloud, next month’s top-rate tax cut also means there will be less help in future from HM Revenue and Customs to boost high earners’ retirement funds. So there are just a few weeks left in which people fortunate enough to be able to write a cheque for up to £200,000 can get £100,000 of it back, risk-free, from the kindly taxman.

Such eye-stretching figures demonstrate why it really can be worth the bother of getting to grips with tax planning ahead of the 5 April fiscal year-end. Incentives to wrestle with the detail of annual tax allowances and exemptions extend right down the income scale. But ignorance can prove an expensive mistake when dealing with HMRC. To cite just one example, there is nothing to stop people who have been basic-rate taxpayers — or even non-taxpayers — all their lives, becoming posthumous higher-rate payers.

Inheritance tax is levied at a fixed rate of 40 per cent on net assets at death worth more than £325,000 per person, or £650,000 per couple. Plenty of unremarkable property in the south-east is worth more than that. So buoyant house prices will push rising numbers of basic-rate taxpayers into the 40 per cent tax band after they die — unless they do something about it.

The simplest way to avoid inheritance tax is to give with warm hands. All gifts, whatever their value, are entirely free from inheritance tax, provided they are made seven years’ before the donor’s death. However, no matter how loving the prospective recipients may seem to be, any parents tempted to give away assets they may need later should study King Lear first. The only form of gratitude you can always rely on is a lively expectation of favours yet to come.

On a brighter note, there is also a £3,000 annual allowance for inheritance-tax-free gifts, and there have always been so many other exemptions that the former chancellor of the exchequer Roy Jenkins was prompted nearly three decades ago to remark: ‘Inheritance tax is, broadly speaking, a voluntary levy paid by people who distrust their heirs more than they dislike the Inland -Revenue.’

Here and now, after a dozen dismal years for the stock market, most investors may wish they were so fortunate as to have any reason to worry about capital gains tax. But a strong start to the year, with the FTSE 100 index enjoying its biggest January rise since 1989, should remind serious investors that it might not take very long for profits to exceed the £10,600 per person capital gains  tax threshold. It’s worth remembering that children have the same capital gains allowance as adults, so parents and grandparents who are keen to keep wealth within the family can have more than one bite at this -cherry.

Similarly, traditional couples in which one partner serves as wage slave while the other enjoys life as a non-earner can also benefit from tax planning. They may minimise liabilities by transferring assets from the taxpayer to the non-taxpayer to make maximum use of the capital gains tax allowance.

The same is true of the £8,105 annual personal allowance before anyone has to pay income tax. Where one partner is a top rate or 50 per cent (reducing to 45 per cent next month) taxpayer and the other a non-taxpayer, transfers of income-yielding assets — such as the buy-to-let properties Alex Brummer writes about on page 33 — can also utilise the 20 per cent and even 40 per cent bands of income tax to minimise liabilities. But it’s important that these transfers are genuine, or the taxman will take a dim view and might even argue that the fine line between avoidance and evasion has been crossed.

Coming down from the financial stratosphere, capital gains and income tax are good reasons for most medium-to-long-term investors to consider using their individual savings account (Isa) annual allowance. Every adult can place up to £11,280 in a stock market-based Isa this year and render any profits from it free of capital gains tax. Income withdrawn from an Isa is also free from further tax and there is no need to declare Isa holdings, gains or income on self-assessment tax returns.

This last exemption is a valuable one for anybody who struggles to locate dividend tax receipts and other bits of bumf when completing the annual self-assessment chore. However, it is important to be aware that Isas do not confer any protection against inheritance tax. More positively, Isas can be used to shelter shares, bonds and pooled funds, while risk-averse savers willing to accept nugatory returns on deposits can place up to £5,640 per person this year in risk-free, tax-free cash Isas. Another attraction of this most flexible tax shelter is that there is no minimum period for which an Isa need be held to earn its privileges and you can do whatever you like with the money.

Sadly, restrictions on the most generous form of tax shelter — pensions — are more onerous. Unless you belong to one of a small number of named occupations, such as jockey, dancer or trapeze artist — I’m not making this up — you cannot withdraw any cash from your pension before you are 55. Even then, when you can take a quarter of the fund as tax-free cash, there are strict rules about what you can do with the rest of your money in this tax shelter.

The main reason to invest in a pension is up-front tax relief equal to the individual’s top rate of income tax. So everyone — including, perhaps surprisingly, children and non-earners — can invest £80 in a pension and have it grossed up to £100 before costs by the taxman. High earners can achieve the same net effect, after they have filled in their tax returns, by giving up just £60 of cash if they are 40 per cent taxpayers or £55 if they are next year’s 45 per cent payers.

This brief overview cannot describe all the rules and restrictions of our notoriously complex personal tax system. Most immediately, remember that Isa tax breaks and others mentioned here are annual allowances. That means you cannot go back to utilise those you failed to take up in earlier years. So, when it comes to year-end tax planning, it really is a case of use it or lose it.

Ian Cowie is head of personal finance at Telegraph Media Group.

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