Many happy returns from the taxman
Joss Harwood of Eldon Financial Planning reveals HMRC’s more generous side. But are you taking advantage of all your tax allowances.
It’s not just the wealthy who can benefit from using tax allowances and thresholds. There are advantages to be had at all income levels, and a significant number of people could become much more tax efficient in 2015/2016 with the new 0% savings rate.
Here are a few examples.
2014/2015 – Lee and Nicky, a couple with 3 children
- Lee will earn £52,000 with a £4,000 bonus and has £48,000 savings and investments, generating a further taxable £2,000. Total income is £58,000 and there are no pension contributions as yet in the tax year.
- Nicky earns £12,500 and has gross taxable savings income of £1,000. Again, there are no pension contributions.
- Three children gives a child benefit entitlement of £2,475 a year.
Child benefit tax charge
As Lee earns over £50,000 (£58,000), 80% of the child benefit (£1,980) will be claimed back via tax.
Using ISA allowances
If Lee had used ISAs (built up over several tax years) there would be £2,000 less taxable income and the child benefit tax charge would be reduced, equating to £495.
Making a pension contribution
If Lee makes a gross pension contribution of £8,000 now (paid net at £6,400), income falls to £50,000 and there is no child benefit tax charge to pay.
- The tax saved and recovered child benefit is £5,180. But what’s more…
- A pension contribution of £8,000 can effectively be achieved for a net cost of £2,820
I’ll just say that again. A sum of £2,820 becomes £8,000, albeit this not available until at least age 55 when it will be subject to the pension rules in force at that time.
Salary sacrifice, whereby an employer reduces salary paid by the amount of a personal pension contribution, has a benefit for individuals earning over £8,000 up to £41,865 as National Insurance (NI) is 12% at this level.
Nicky can join a company pension scheme and contribute by direct contribution or by salary sacrifice. The employer contribution is matched.
For example, 6% of Nicky’s £12,500 annual salary is £750. Contributions would receive tax relief at source. Therefore the pension contribution would cost Nicky £600. Personal NI would be £545.28 over the year.
With salary sacrifice, the employer makes Nicky’s contribution and reduces salary accordingly. The pension contribution is still £750, but Nicky’s lower earnings means an NI saving of £90.
- So although Nicky has ‘lost’ £510 in take-home pay over the year, she has gained £1,500 in her pension.
- The employer also saves £103 NI over the year, and so (being no ‘worse off’) may add this to the member’s pension, giving a further boost.
2015/2016 – the new tax free savings band
In 2015/16 the starting rate for savings will reduce from 10% to 0%, and the band on which this applies will be increased from £2,880 to £5,000. The personal allowance will be £10,600. These thresholds are key.
For instance, Lee’s retired parents will each have pensions under £10,600 in 2015/16 plus taxable interest of less than £5,000 each. Under the new regime this gives a potential household tax free income of £31,200. They have most of their holdings within ISAs and the withdrawals they take have no further tax liability. This is a very strong position to be in.
If your savings plus earnings is less than £15,600 in 2015/2016, you can register for gross interest with your bank or building society. If earnings are less than £15,600, but earnings plus savings interest is more than £15,600, you cannot register, but can claim back the excess interest deducted at source, to the £15,600 threshold.
If you are in a couple, you should seriously consider rearranging your affairs by allocating savings income to one partner or the other, where there would be a meaningful benefit.
Together, all the above allowances and tax efficiencies can add up to a considerable windfall from the taxman, if you can take advantage of them. Talk to an adviser today to make sure you’re not missing out.
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