Use it or lose it: tax allowances

Use it or lose it: tax allowances

We’re not yet nearing the end of the tax year quite yet, but we are just over halfway there, and it’s always best to prepare. Life has picked up its pace again, and the months are zooming on by, but are you making sure to use up your tax allowances while you still have plenty of time to do so?

We all have the best intentions with money, but sometimes things get left to the last minute, and the end of the tax year is arguably the busiest time for financial planning firms like ours. So before the panic ensues, this is your midway reminder to make sure you’re taking advantage of the tax allowances that could boost your savings.

People often mistakenly think they need to invest lots of money to make a good return, but sometimes investing a bit of time is all you need. You can significantly improve your financial situation by being well informed and making wise financial decisions to minimise your taxes and utilise all of your tax allowances. Before the clock resets for the new tax year in April, you’ll want to use your tax allowances or risk losing out on simple savings.

2021/22 tax allowances

The 2021/22 tax year will end on 5th April 2022, so here are some of the vital tax allowances you’ll not want to miss out on:

  • A £20,000 ISA allowance, which you can split across various types of ISAs
  • A £40,000 pension annual allowance (subject to criteria and restrictions)
  • A Junior ISA/Child Trust Fund allowance of £9,000 for each of your children (grandchildren)
  • A capital gains tax allowance of £12,300 for individuals – remaining at this level until 2026

Using your tax allowances

Here are the four main tax allowances and areas of planning that you’ll want to build into your savings strategy.

Think about Pensions

Tax relief applies to your pension contributions at your highest rate of income tax, so by paying into your pension, money that would’ve otherwise gone to HMRC will instead help to boost your retirement savings. So not only does paying into your pension help reduce the amount of tax you pay, but it also helps strengthen your savings pot for later life.

When making pension contributions, you can pay up to the greater of 100% of your earnings, or £2,880. In addition, you receive tax relief of up to 45%, but restrictions apply. So, for example, if you pay income tax at 20%, if you pay £80 into your pension, you’ll get £100 with tax relief added. Similarly, if you pay tax at 40%, you’ll only pay £60 to get the same £100 in your pension, and if you pay tax at 45%, you’ll only need to contribute £55.

Because tax relief is so beneficial, as the above examples show, there are limits in place. There is an annual limit and a lifetime limit for tax relief; the Annual Allowance is £40,000, and you may be able to carry forward any unused allowance from the previous three tax years. However, this could reduce further if you’re a high earner or have accessed taxable income from a Defined Contribution pension. The Lifetime Allowance is the limit on the total amount you can build up in your pension pots combined, and it is currently £1,073,100.

You can use a pension tax relief calculator to work out exactly how much you could be saving.

Think about Individual Savings Accounts (ISAs)

If you have money sitting in a savings account somewhere earning very little interest, it might be better off in an ISA, where you can take advantage of the annual tax-free ISA allowance of £20,000.

Your ISA allowance can go towards one or a variation of different cash and stocks or shares ISAs. So, for example, although the Lifetime ISA allowance is £4,000 per year with a 25% government bonus of £1,000, you can then pay the remaining £16,000 allowance into a Stocks and Shares or Cash ISA in the same tax year.

And, as mentioned above, if you have children, the Junior ISA (JISA) allowance is £9,000 per child for 2021/22. Although a JISA has to be opened by a parent or legal guardian, anyone can contribute to the annual limit, so if you have grandchildren or nieces or nephews that you’d like to help, then that’s possible too.

Think about gifts

Over your lifetime, those lucky enough will accumulate wealth that can pass on to your nearest and dearest. But, depending on the amount you leave behind and the amount you’ve given away, there might be Inheritance Tax (IHT) to pay.

However, to maximise the amount you leave to your loved ones, making the most of your gift allowances whilst you’re alive will reduce the value of your estate and allow them to put the money to good use a bit sooner.

You have an annual gift allowance of £3,000 per year, and you can carry forward any unused allowance from the previous year. There are also additional gift exemptions include wedding gifts, gifts out of regular income and small gifts.

There’s also the seven-year rule to remember – gifts of any amount can be made (unless into a trust), and if you survive seven years, there’s no inheritance tax to pay. For more information on this, we previously rounded up everything you need to know about gifts.

Think about Capital Gains Tax (CGT)

Capital Gains Tax (CGT) is a tax on the profit you’ve made when you sell an asset. Certain assets are exempt from CGT, such as ISAs, Pensions and your primary residential home. You can benefit from capital gains up to the capital gains tax allowance of £12,300 in 2021/22, and married couples/civil partners who own assets together can claim an allowance of £24,600 combined.

There are two key things to remember when it comes to CGT; the first is that you won’t need to pay any CGT on the sale of shares or units held in an ISA, premium bonds, UK government gilts or gambling winnings. And the second is you won’t face a CGT charge if you transfer assets to a civil partner or spouse.

For a full breakdown of the key tax planning areas, you can read our previous blog on tax planning for 2021/22.

Three tax planning mistakes to avoid

1. Waiting until the last minute

Tax planning is a complex area of your finances, so we always recommend seeking professional financial advice before making any crucial decisions. And since there’s usually a degree of collaboration, you don’t want to be making last-minute, spur of the moment decisions that won’t give you time to think about why you’re making that decision and what it’s helping you achieve.

2. Not having a clear set of financial goals and objectives

Growing your wealth shouldn’t be the aim, and saving for the sake of it is often unproductive. Your money should meet your needs and serve a purpose. To utilise it to its fullest potential, you should work out what you need and want to achieve. Then you can start to think about how much that is roughly going to cost and how you can save that amount.

For instance, if you want to buy a new home in the next ten years, you might not want to place your savings in an investment that keeps it locked in for a long time. Or, if you’re saving for later life, you might want to take a little more risk if you know you won’t be touching that money in the short term.

Any financial decisions you make should be goal-driven. And, once you work out how much you are saving by making the most of various tax allowances, you can attribute your excess savings to specific financial goals. To help with your goal-setting endeavours, view our guide to setting financial goals and objectives for your future.

3. Not understanding the different tax allowances

Understanding the tax relief available to you and implementing a tax planning strategy will help boost your savings significantly. It may not seem like a lot, but just think of the compounding effect!

Having confidence in your financial choices is one of the many reasons why financial planning is so important. And you don’t need to become an expert. Instead, simply speaking to your financial adviser when you have any queries will help demystify this complex area of financial planning.

And on that note, if you have any tax planning or other questions, then please don’t hesitate to get in touch and speak to one of our expert financial advisers.