With the tax year-end fast approaching there are a number of tax planning loose ends that must be tied up.
Where possible clients should consider: maximising their annual pension contribution; taking up unused pension allowances from 2008/2009, 2009/2010and 2010/2011; maximising capital gains tax allowances, as well as taking advantage of inheritance tax reliefs (such as the £3000 yearly exemption).
However, the most straightforward and obvious tax break available to savers and investors are Isas. An Isa is very much like a wrapper, within which interest earned on cash and return on investments, as well as any capital gains are virtually tax-free. They are a particularly compelling argument at a time of record low interest rates. So, let us look at the tax breaks and allowances.
The headline figure of £10,680 is the most compelling. There are three options when it comes to clients using their total limit of £10,680 for this year, which can all be put into investment funds or stocks and shares. Or half of it – £5340 – can be put into a savings account, or one can mix the two and have up to half in cash and whatever is left in investments.
With the 2011/2012 annual allowance at £10,680, rising to £11,280 for 2012/2013, a couple could invest up to £43,920 tax-efficiently by using this and next year’s allowances. It should be noted that it is important to keep a stash in cash that can be accessed easily in the event of an emergency.
Over the long term, economic studies show that a stocks and shares Isa has the greater potential to produce higher returns, as history will tell us, and in this climate of low interest rates and the fact that returns are virtually tax-free clients who take a long term view will do better.
For those who do not have a large lump-sum to invest, then a one-off payment of say £500 could be contributed, or a regular savings scheme committing £50 a month should be considered. In actual fact this is a ‘must have’ for the would-be or starter private investor and the beauty of a regular saving scheme is pound cost averaging, which means that clients can benefit from some smoothing to volatility in the stock market.
Anyone can open an adult Isa so long as they are 16, although one needs to be 18 to invest in stocks and shares or investment funds. The Junior Isa was launched in November last year and has an annual limit of £3600 and is open to those under 16. This makes a fabulous present to children, grandchildren and godchildren.
Let us examine the virtually tax-free nature of Isas. Clients may overlook the fact that they are paying tax on their normal savings. In a normal savings account, basic rate taxpayers pay 20p of every pound of interest they earn; this goes up to 40p and then 50p for higher rate taxpayers. One needs to stress that every pound of interest earned in a cash Isa is tax-free.
For investment Isas, clients can choose to buy into investment funds or individual stocks and shares. Normally one has to pay capital gains tax of between 18 per cent and 28 per cent on any investment returns over £10,600 a year (depending on their tax rate). However, so long as the investments are within an Isa, there will be no capital gains tax to pay, no matter how big the returns are.
Similarly, while Isas, like individuals, cannot reclaim the 10 per cent tax credit on dividends, there is no further tax to pay when compared to the 32.5 per cent or 42.5 per cent tax that higher rate and additional (50 per cent) rate taxpayers would pay outside of an Isa.
There are almost 300 hundred cash Isas available and thousands of investment options to choose from. Clients should use a qualified, independent adviser to help make the right decision and make sure the full charges of any investments are carefully considered to avoid excessive charges that could eat into returns. Depending on clients’ attitudes to risk, advisers will be able to guide clients in an appropriate and suitable way.
It is worth establishing the pros and cons of cash against stocks and shares and/or a combination of both. The cash option is simple to open and easy to run and gives one a level of interest over a fixed period. I have mentioned the wide range of accounts to choose from in the market and they should be considered on their merits and the flexibility that clients may wish for – easy access or fixed for a longer term. But then for that level flexibility or the benefit of a guaranteed return, one should also ponder the cons: the likelihood of inferior long-term returns and the relatively low rates of interest, particularly when weighted against the inflationary pressure we have seen recently. Also it should be noted that as and when competition among providers hots up, clients may need to switch to take advantage of the best rates on offer and switching can be fiddly and also time-consuming. Last year’s table-topping best buy account could be run of the mill this year.
The stocks and shares route will attract those who are able to be more speculative and wish for a wide range of investment choices and have the understanding that they could lose money. They provide a useful virtually tax-free income after retirement. However, if clients need easy access to their cash, or are worried about the vagaries of the stock market particularly in the short term, then they are best avoided.
Finally, it is worth noting that as with all tax year-end planning, if one does not use the tax-free allowances they will be lost. Also these allowances are best used at the start of the tax year, to give them longer to perform. There are also practical points to be addressed. Clients should be encouraged to act now and not leave it until the last minute. Ideally, everything should be done and dusted by the end of March in case there are any administrative hitches.
Simon Goldthorpe is a director of Beaufort Asset Management
