Making the most of income tax savings

Angela Haythorne, financial planner at JLT Wealth Management, explains the many and varied ways you can help reduce your clients’ income tax liabilities...

With the end of the 2011/2012 tax year rapidly approaching, it is worth individuals considering opportunities available to reduce their income tax liability and make the most of available tax allowances through investments.

Income tax

As we are all very much aware, income tax is something we all need to bear. Individuals under the age of 65 currently benefit from a personal allowance of £7,475 with income tax then payable on earnings depending on varying bands.

For 2012/13 the personal allowance will increase to £8,105 although the basic rate limit will reduce to £34,370 which results in a freezing of the threshold within which individuals pay basic rate tax.

In addition to this, the personal allowance reduces by £2 for every £1 of excess income over £100,000, therefore removing the personal allowance completely for income over £114,950 in the current tax year (£116,210 in 2012/13).

Pension contributions

Pension contributions have long been a way of reducing income tax liability, with individuals benefiting from income tax relief at their highest marginal rate for pension contributions made. Contributions can be made up to 100% of earnings, subject to an annual allowance of £50,000 each tax year (and within lifetime limits).

Since April 2011, there is also a three year carry forward rule that allows individuals to carry forward unused annual allowances from the last three tax years. The initial workings of the Finance Bill 2011 have been amended recently with revised guidance published on 25 November 2011, allowing any payments over £50,000 in the last three years to be ignored in the carry forward calculation.

For tax planning for those with earnings over £114,950 currently (£116,210 in 2012/13) a pension contribution in the tax year will allow them to recover some of the personal allowance otherwise lost and provide significant tax relief.

In the current economic climate, increasing income tax bills and with state pension age set to increase from 2018, personal pension contributions and building up additional pension funds for retirement are offering more value than ever to many individuals. Examples of how this may benefit an individual’s income tax position are shown in examples A and B.

Other areas to consider

In addition to pension contributions, it is also worth remembering other ways of income tax savings at this time of the tax year and the opportunities that are available to individuals.

Individual Savings Accounts (ISAs)

Allowances of up to £10,680 per person in the current tax year (£11,280 in 2012/2013) providing a investment opportunity free from income tax and Capital Gains Tax (CGT). Junior ISAs are now also available with a maximum allowance of £3,600 each child per tax year.

Capital Gains Tax (CGT)

Net gains on both business and non business assets in excess of the individual annual exemption of £10,600 (£5,300 for certain trustees and frozen for 2012/2013) are subject to tax at 18% for basic rate taxpayers, and 28% for higher rate taxpayers and trustees. Losses can be carried forward from previous years to offset gains.

Venture Capital Trust (VCT) / Enterprise Investment Scheme (EIS)

UK investors can benefit from up to 30% income tax relief on the amount invested in VCTs and EISs, subject to their tax liability for that tax year, and holding shares for the minimum terms that apply.

Example A:Income: £115,000

Example B:Income: £160,000