To download a PDF version of this document, click here
Date of publication: January 2012
Benjamin Franklin's view that nothing is certain except death and taxes has yet to be disproved. However, the best way to mitigate at least some of your tax liability is to make sure you use the tax allowances available.
There are a number of tax allowances granted to you by the Government. You have a personal income tax allowance, an annual exemption from capital gains tax and there are numerous tax credits available depending on your circumstances. Schemes like Gift Aid also offer relief, if you make donations to a charity. And you have an Inheritance Tax (IHT) allowance for when your estate is passed on.
On top of these there are also tax efficient investment products, such as Individual Savings Accounts and pensions. These are the straightforward ones and give you relief from both income and capital gains tax (CGT) to different extents. Other more complex or higher risk investments can extend the level of relief, depending on your situation.
In addition, some individual assets that you own are also specifically exempt from CGT even if they are sold at a profit. Typically, these include your home, your car, certain personal jewellery, antiques and UK Government bonds (gilts). In addition, there are ways to mitigate CGT, such as giving away assets to your spouse.
For the 2011/12 tax year, your Inheritance Tax (IHT) allowance is £325,000 (£650,000 for married couples and civil partners), but anything you leave in your estate that takes the total above this amount will leave a liability. This can result in beneficiaries having to sell family heirlooms to pay the tax bill. However, a little bit of planning can help you access the range of annual exemptions and allowances which are available in advance. This can help you reduce the liability – or provide the means with which your beneficiaries can pay it without having to sell items of sentimental value.
For most people, using your tax allowances could simply be a matter of adjusting your portfolio to maximise use of the various allowances and savings products. For others, the process is more complex. A professional adviser can help you through the maze and help you find the best set of solutions for your personal needs.
This tax year (2011/12), every individual is entitled to earn up to £7,475 before becoming liable for any income tax. Above this you pay income tax, starting at 20%, and rising to 50% depending on how much you earn. This means you could be working up to 30 minutes in every hour, just to pay for the Government.
Consequently, most people try to minimise their liability. As dividends count as income as well as wages, a married couple could start by re- assigning any income producing investments to the lower earner. If one spouse is a higher rate tax payer but the other is not, then any income producing investments should be in the name of the spouse earning least. This could prevent them being made liable for the full 50%. In addition to a personal allowance, you can also use the tax advantages of an ISA (Individual Savings Account). This shelters any dividends you receive from your investments, from any further income tax.
You can also contribute to a pension plan - while this may not minimise your tax liabilities up front, it does enable you to earn a rebate on your contributions. For each pound of contribution, 20% is claimed as a tax rebate from the Government, meaning that you get £100 in your pension for a contribution of just £80. Indeed, if you pay higher rates of tax, subject to certain limits on earnings and investment contributions, you could get even more rebated back into your plan.
Every time you sell something, the taxman takes a look to see if you've made a profit. Under normal circumstances this is not an issue - as anyone who has ever sold a car will tell you, losing money is easy. However, with investments, the whole idea is to make a profit - and this is where the taxman gets interested.
Whenever you profit from the sale of a qualifying asset, you are deemed to have made a 'capital gain'. This is calculated on the difference in value between the price at which you bought the asset (or its original value if you were given it) and the price at which you sold it, minus any expenses incurred in the transactions. But very few people pay Capital Gains Tax (CGT) in full because with just a little bit of planning, you can minimise your liability.
First, you have some exemptions - your main residence, certain personal jewellery and your car, for example. In addition, you have an annual allowance (£10,600 for 2011/12) below which any gains realised are also tax free. There are some limitations over how this can be used, but it might be possible to stagger the sale of your assets so that you use this allowance every year, or use a sale to help reset the base value of an asset against which future gains will be measured.
Finally, you can use your partner's allowances - as transfers between spouses are CGT free - or Individual Savings Accounts which shelter investment gains from CGT completely.
Despite the threshold rising to £650,000 for married couples and civil partners, (£325,000 for individuals, tax year 2011/12) the boost in house prices over recent years means inheritance tax (IHT) could still be a concern. It is therefore sensible for investors to consider the potential liability they may be leaving behind.
For most, the key contribution to the value of their estate will be the family home but it is not the only asset that counts. For example, ISA investments shelter investors from capital gains and income tax but not from IHT. Property held abroad also counts towards the total. The problem with IHT is not just that it has to be paid, but that it generally has to be paid quickly. Therefore, without a little planning, the family home or precious heirlooms may need to be sold to meet the bill.
However, there are things you can do to offset the impact. For example, you have an annual gift allowance of £3,000 a year. Certain gifts for weddings, from parents, grandparents and even friends, are also exempt. Other useful tools, despite recent changes, include loan trusts and discounted gift schemes - indeed, there are a myriad of options available, some more complex than others.
Given the changes in legislation which the Government is using to try and close the potential tax loopholes, it is always worth getting professional advice on the best way to ease any burden on your estate.
This guide does not contain a full statement of the law and it does not constitute legal advice. Please seek legal advice if you have any questions about the information set out above.