Chancellor Rachel Reeves is gearing up to deliver her first Budget on 30 October, and experts have warned a tax raid is on the agenda. It is possible you are scrambling for ways to shield your money from the taxman as a result.
The good news is Labour has promised not to raise income tax, National Insurance or VAT, but the bad news is tax rises are likely in a range of other areas. It comes after Reeves accused the Conservatives of leaving a £22bn black hole in the public finances, meaning money will need to be raised from somewhere to pay for vital public services.
There are a range of possible targets, from capital gains tax to inheritance tax. Your pension pot could also be in the firing line, if Labour decides to cut pension tax relief or scrap the 25% tax-free pension cash.
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We won’t know the specifics until Budget day arrives, but thankfully there are some pre-emptive steps savers and investors can take to legally shield their money from the taxman. “The key is to identify those that work for your overall finances, which you’ll be grateful for even if you don’t get the changes you were expecting,” says Sarah Coles, head of personal finance at Hargreaves Lansdown.
We share five steps you can take to cut your tax bill.
1. Top up your pension
It is rarely a bad idea to top up your pension. Retirement costs have soared in recent years and almost 40% of people are not saving enough to support a basic retirement, according to research from pensions company Scottish Widows. This isn’t the only reason you should top up your pension, though. Pensions are also an incredibly tax-efficient way to save for the future.
Each time you pay into your pension, you benefit from something called pension tax relief. Through this policy, HMRC effectively refunds you the income tax you originally paid on the money when you first earned it. There are a couple of important considerations to bear in mind:
- The refund is paid at your marginal rate (20%, 40% or 45%). All savers receive the 20% refund automatically, but higher and additional-rate taxpayers will need to claim the remainder by filing a tax return.
- You can contribute up to £60,000 to your pension each year in total and still benefit from pension tax relief. This includes the contributions from HMRC and your employer, as well as any money you pay in yourself.
Pension tax relief isn’t the only perk, though. On top of this, any capital gains or income you earn in your pension is shielded from the taxman. This is particularly valuable now that the dividend and capital gains allowances have been slashed to £500 and £3,000 respectively.
Ahead of the October Budget, investment platforms Hargreaves Lansdown and Interactive Investor have both reported an increase in the number of people boosting their pension contributions. Hargreaves says it has seen a 71% increase in this behaviour compared to last year, while Interactive Investor has seen a 64% increase.
It is possible the government will change the rules on pensions as part of the Budget – we share further analysis in: “What does a Labour government mean for your pension?”, “Will Labour change the rules on pension tax relief?” and “Will Labour axe the 25% pension tax-free cash?”
However, “any significant policy shifts typically go through extensive consultations and legislative processes,” says Myron Jobson, senior personal finance analyst at Interactive Investor. “This means you'll likely have ample time to understand and adapt to any confirmed changes,” he adds.
2. Take advantage of ISA allowances
Each year, all adults are entitled to stash up to £20,000 in an Individual Savings Account (ISA). This is a tax-efficient wrapper where you can hold cash or investments like stocks and shares. Any income or capital gains you earn is shielded from the taxman.
Commentators have warned that capital gains tax (CGT) could be a target in Reeves’s upcoming Budget. A number of options are available to her, from increasing CGT rates to further reducing the annual capital gains allowance.
If these rumours materialise, the best place for your money to grow is in a tax-efficient wrapper like an ISA or pension. If you are weighing up the pros and cons of an ISA versus a pension, it is worth remembering that pensions offer more generous tax breaks overall, but ISAs offer greater flexibility.
“With the tax environment becoming ever more hostile, people should make as much use of [ISAs] as possible,” says Jason Hollands, managing director at wealth management firm Evelyn Partners. “Many people leave opening an ISA to the final months of the tax year, but if you have the cash available to bring this forward to before the Budget, it really does make sense to do so early this year.”
If you have already maximised your own £20,000 ISA allowance, you could consider contributing to a junior ISA on behalf of your child. Children have their own £9,000 ISA allowance each year. It is important to note that a junior ISA legally belongs to the child, so you won’t be able to access the money. Only the child will be able to access the funds once they turn 18.
3. Look into “Bed and ISA” rules
“Bed and ISA” transactions are becoming increasingly common as investors look for ways to protect their dividends and cut their capital gains tax bill. This type of transaction involves transferring existing assets into an ISA wrapper where any future capital growth or income will be sheltered from the taxman.
It essentially involves selling your existing assets and repurchasing them back within the ISA. A provider can manage this on your behalf. Crucially, by selling existing assets and realising gains of up to £3,000, you can stay within your annual CGT allowance. “This process has a ridiculous name, but is an eminently sensible approach for those with portfolios stretching beyond ISAs,” says Coles.
There are some fees involved in "Bed and ISA" transactions, so you should find out how much the transaction will cost on your platform before moving ahead. It is likely the tax benefits will far outweigh the costs.
4. Cut your inheritance tax bill by giving gifts
The government has been raking in increasingly large sums of inheritance tax (IHT) in recent years. So far this year, IHT receipts have already hit £3.5bn (April-August) and there are still seven months to go before the new tax year begins. With this in mind, we are already on track to beat last year’s record of £7.5bn.
The rate of inheritance tax is unlikely to go up in the upcoming Budget, given it is already one of the highest tax rates at 40%. However, some experts have suggested Labour could consider charging capital gains tax on inherited assets, resulting in a ‘double death tax’ of more than 50%. Another option would be to reduce the current tax-free allowances, known as the nil-rate band and the residential nil-rate band.
Fortunately, there are some strategies you can use to pass on more of your estate tax free. For example, each year, you can give away up to £3,000 in gifts without being liable for an inheritance tax bill. Anything above this limit will be classified as a “potentially-exempt transfer”, meaning you will need to outlive the gift for seven years to avoid IHT entirely. After three years, you can make use of a sliding scale known as taper relief.
If you want to reduce your family’s IHT bill, it could be wise to make use of gifting rules sooner rather than later. There is currently speculation that the chancellor could tighten up the rules around potentially-exempt transfers. “[This] has got some families wondering whether they should set the seven-year clock ticking on a lifetime transfer now or in the next few weeks,” says Laura Hayward, tax partner at Evelyn Partners.
5. Use your CGT allowance in the most tax-efficient way
With CGT a likely target in Reeves’s upcoming Budget, it is more important than ever to take advantage of your CGT allowance in the most tax-efficient way possible. Remember, gains are only realised when you sell an asset, and everyone has a £3,000 tax-free allowance every year. This renews at the start of the new tax year on 6 April.
If you are married or have a civil partner, you could consider transferring some assets into your spouse’s name for tax purposes. This could be advantageous if you have already used up your £3,000 CGT allowance, but your spouse hasn’t yet maximised theirs.
Another good tip is spreading your gains out over a sensible period of time. For example, if you are building up a big investment gain, you could consider gradually selling the investment over time to spread the gain over several tax years (£3,000 at a time). Of course, the risk is that the capital gains allowance could be cut even more further down the line.
Remember that you can also offset any losses and deduct any unused losses from previous tax years to cut your CGT bill.
Remember: don’t panic or make rash decisions
It is easy to panic with the threat of tax hikes on the horizon, however it is important to avoid making rash decisions. For example, Interactive Investor reported a 58% increase in the volume of tax-free cash withdrawals from SIPP accounts in September.
It is unsurprising when you consider the rumours that have been doing the rounds. Many are concerned that Labour will cut the 25% tax-free pension cash, and are rushing to take advantage of the current rules. But this could put them at a disadvantage over the long run.
Jobson says: “Taking a tax-free lump sum of up to 25% reduces the amount of money in your pension pot, which will decrease the amount available for your retirement income. The remaining 75% of your pension pot, when accessed, would be subject to income tax at your marginal rate, meaning any withdrawals or annuities purchased with the remaining pension could be taxed as regular income.
“By taking out a big lump sum, you also reduce the amount that could potentially grow with investment returns, which could have a profound impact on the total value of your pension pot over time.”
With this in mind, taking your tax-free pension cash in instalments could be a better option than withdrawing it as a lump sum.
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