What can individuals do to avoid penal tax rates on their savings without resorting to outdated complex schemes?
We are now well into our first year of the 50% tax rate for those with income of more than £150,000, and the 60% tax rate for those with taxable income between £100,000 and £112,950, who have lost their personal tax allowance.
To avoid these rates, there are a number of tax efficient options open to most people, including tax reliefs and allowances, tax-free investments and tax shelter investments. Reliefs and allowances It is relatively unusual to find both husband and wife each with taxable income of more than £150,000. More often, one spouse does not have much taxable income at all.
A very simple and tax efficient way of reducing a family's tax rate is, therefore, to transfer taxable savings to the low or no income spouse. He/she can then use his/ her own personal tax allowances and basic rate tax bands to reduce their joint income tax rates.
Furthermore, both husband and wife have annual capital gains tax (CGT) allowances of £10,100 each for 2010/2011, which can also be used with simple planning.
Inter-spouse transfers of assets are not subject to CGT so assets can be transferred between spouses to ensure that each spouse's allowance is used. Before gains are realised, it's worth bearing in mind that capital gains are subject to tax at 18% in the hands of basic rate taxpayers.
Completely tax-free investments are limited now to Premium Bonds, National Savings Certificates (£15,000 per issue) and Children's Bonus Bonds (£3,000 per issue). Some collectors' items such as classic cars, coins and some personal chattels, depending on their value, are also exempt. Individual savings accounts (ISAs) are sometimes considered to be tax-free investments. However, withholding taxes on dividends cannot be recovered. For income tax purposes this means that ISAs are on an equal footing with other equity-based investments in the hands of individuals who pay tax at the basic rate. They are not subject to CGT when disposed of and the current annual ISA allowance of £10,200 should enable a couple to accumulate a fairly sizeable pot inside these vehicles over the years.
Tax shelter investments
Tax shelter investments tend to allow you to defer your tax liabilities until a later time as well as sometimes giving you a tax-free element. Typically, they roll-up free of all taxes until they are surrendered or encashed. The most typical are pension plans, insurance bonds and offshore maximum investment plans or endowments.
Like ISAs and pension plans, insurance bonds can grow free from all taxes if they are based in an offshore jurisdiction. However, UK-based insurance bonds will have their investment income and growth taxed as they go along at a rate of between 15% and 20% per annum.
'Tax-free' withdrawals of up to 5% of the original capital investment can be taken each year, and, to the extent that this allowance is not used in any one year, it can be carried forward.
They can be fully encashed at any time and have no fixed maturity date. Provided they are set up with multiple lives assured, investors can plan their encashments to coincide with lower tax rates.
Like pensions, offshore bonds can invest in the widest range of investment classes, generally through collective funds. It is a myth that they are expensive relative to other investments, although it is recommended that you do take proper advice on charging structures from someone who is fully conversant with them.
Pensions are a good investment as they attract upfront tax relief, while the fund can grow almost entirely free of tax, and 25% can be withdrawn tax-free on vesting.
Maximum investment plans and endowments
Maximum investment plans and endowments are regular premium insurance policies. Provided premiums are paid for at least 75% of a ten-year term and they do not vary within specified limits, tax is limited to insurance company rates of between 15% and 20%. There is no further higher rate tax to pay on encashment.
Again, these investments provide access to a wide range of asset classes and expert advice should be obtained to ensure that you get the best terms available and the widest range of investment options.
Other tax efficient investments
Venture capital trusts, enterprise investment schemes, film partnerships, AIM stocks and timber are not considered to be part of a typical savings portfolio. They tend to be highly specialised investments used, in some cases, to take high risks on start-up companies or a basket of them, or to plan for inheritance tax. In future issues of Family Wealth Management we will take a detailed look at these types of investments. Also see the feature on commercial forestry later in this newsletter.
This is just a taste of some of the options available for avoiding the 50% tax rate. If you need more information about these or other tax efficient savings plans, get in touch with your usual Smith & Williamson contact or call one of the people listed on the back page. Some tax efficient investments carry a high risk that some or all of the capital invested could be lost. It is important to take appropriate advice before proceeding with such an investment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.