In the aftermath of the COVID-19 pandemic, the Government announced the 2021 Budget and its plans for economic recovery. Whilst there were no painful tax hikes, the subtle changes haven’t gone unnoticed. So, let’s dig a little deeper into the big tax freeze of 2021/22.
We’ve touched on the tax changes in our Budget breakdown, looked at the key tax planning areas to focus on for 2021/22. Now we want to focus specifically on the frozen allowances and how they might impact you.
What is the big tax freeze?
Before the Spring Budget, there was a lot of speculation about how the Chancellor would attempt to repair public finances in the year ahead. Despite rumours that there would be increases in tax rates, the only tax changes of note were the series of frozen allowances.
From 6th April 2021, the big tax freeze affected:
- Income tax
The tax-free personal allowance will remain at £12,570, the higher-rate tax threshold will stay at £50,270, and the additional rate will also remain at £150,000.
- Capital gains tax (CGT)
The CGT Annual Exempt Amount will remain at £12,300 for individuals, and £6,150 for trustees, until 2026.
- Inheritance tax (IHT)
The IHT allowance of £325,00 (plus an extra £175,000 if you pass on your property to a direct descendant) will remain until 2026.
- The lifetime allowance (LTA)
The pensions LTA will also remain at £1,073,100 until 2026.
Breaking down the tax changes
You will receive the first £12,570 of earnings tax-free unless you earn over £100,000 and your personal allowance starts to reduce.
The first slice of taxable income up to £37,700 is subject to 20% tax. So combined with your personal allowance, you can earn up to £50,570 without going into the higher-rate tax band. Taxable income over £37,700 is charged at 40% tax, and any taxable earnings over £150,000 will suffer 45% tax.
The Office for Budget Responsibility estimates freezing these thresholds will lead to an additional 1.3 million people starting to pay income tax. And a further one million will become higher-rate taxpayers by 2025/26.
So, although the Government haven’t raised the rates of income tax, more people will naturally shift into a higher bracket due to the freezes.
Capital gains tax
The capital gains tax (CGT) is a tax on the amount of profit made on selling an asset. You only have to pay this pax if your gains in a year go over the tax-free allowance (£12,300 or £6,150 for trusts).
There are two different rates of CGT, one for property and another for any other assets. These rates vary depending on your tax bracket.
For the higher-rate taxpayer, the CGT rate on assets is 20%, and the rate on a property is 28%.
If you’re a basic rate taxpayer, the gain needs to be added to your taxable income to work out the rate. You will pay 10% (or 18% for residential property) tax if the gain plus your taxable income is less than the basic rate tax band. You will pay 20% (or 28% for property) on the amount over the basic rate tax band.
To alleviate CGT, charitable giving and transferring assets between spouses or civil partners are all exempt for CGT. Gains within ISAs and pensions are also free of CGT.
The inheritance tax (IHT) allowance is the amount you can pass onto your heirs tax-free. Currently set at £325,000. You may also benefit from the residence nil-rate (if you are leaving property to a direct descendant), which is £175,000. However, if you’re married or in a civil partnership, this allowance is transferrable, in which case the total IHT allowance a couple can have is £1m.
If you leave anything above the IHT threshold, your loved ones will be liable to pay 40% on the excess. It’s also worth noting that the residence nil-rate band only applies if your estate falls under the value of £2m.
The IHT nil-rate band has stayed at the same level since 6th April 2009, so it is no real shock that this threshold will remain frozen until 2026.
There are various tax planning strategies to help minimise your inheritance tax, from giving money away during your lifetime, taking advantage of the available IHT exemptions and insuring against the tax liability.
We cover all of the above in our latest webinar, which you can view online here.
The lifetime allowance
The lifetime allowance (LTA) is the overall limit on the total pension funds you can accrue during your lifetime before incurring a tax charge. The current LTA is £1,073,100 and will stay at this level until 2026.
Pension benefits are tested against the LTA when taken, and if the cumulative value exceeds the allowance, there will be a tax charge on the excess. Lump sums are subject to 55%, and income is subject to 25% on top of the income tax you might also pay.
The lifetime allowance had been rising in line with CPI since 2018/19, and the total increase was £73,100 during this period. Estimates based on CPI inflation returning to a more reasonable 2.5 per cent could have seen the LTA at just under £1.2m in 2025-26.
As a result of the freeze, and as inflation continues to rise, more savers will be caught by the LTA charge.
However, the LTA charge is intended to recoup the tax relief previously added to contributions. For some, the freeze to the LTA will result in a tax on the growth experienced during this time.
When it comes to tax planning, the best way to make your money do more is to plan ahead and think about how you can organise your finances over your lifetime to make the most out of the available tax allowances so that you can minimise the chances of future tax liabilities while maximising the money that you have.
With so many rules and regulations to be aware of, the world of tax planning can be hard to navigate. At this point, the assistance of a professional financial planner can prove invaluable.
If you have any questions or would like to discuss your finances or an existing financial plan, please don’t hesitate to get in touch and speak to one of our professional financial planners.
Helpful resource – there are various government tools and calculators to help you work out your tax.