Your Money Housekeeping Calendar for MARCH
I want to call you to URGENT action on the most frequently missed tax year end opportunities.
- ISA (Individual Savings Account) – a chance to hide £20,000 from the tax authorities – and it’s completely legal!
- Dividend – get £2,000 of tax-free income.
- Capital Gains Exemption – clean off the tax liability that is clinging to some of your gains.
None of these allowances can be carried forward to the new tax year so it is important to take the action now as tax year end is 5th April, but in reality the action needs to have been completed by end of March as it takes a few days to process things.
ISA – Individual Savings Account
These accounts are very generous tax wrappers – anything inside one of these is tax exempt. You don’t even have to tell HMRC (Her Majesty’s Revenue & Customs) about them – they are completely off the tax authorities’ radar when it comes to your personal tax affairs.
Tax free interest, income, dividend, growth – it’s all tax free. Whoopee!
Many people think of an ISA as an investment or a savings account, but it serves you much better to think of it as an envelope – a free envelope given to you by the tax authorities. You can pick up one per year and pop some goodies inside that will be tax exempt all the time they stay in the envelope.
There is a limit to how much you can stuff into your envelope (see table) and it has to be done within the tax year because the envelope is sealed off from further contributions at the end of the tax year.
You can decide if you want to put cash or investment in your ISA – in fact you can do a bit of both if you want to, but here’s the thing: Cash only produces interest and for sure that would then be tax free, but investments can produce interest, dividends, yields and capital growth so there is much more to be gained from protecting all these returns from tax erosion.
Most of the time, interest on cash savings fits within our Personal Savings Allowance anyway, and so wrapping it in the ISA doesn’t gain us much, but it is better to use the allowance by putting cash in the envelope than to waste it if you are not ready to invest – here is why:
First– We are expecting interest rates to rise – At the moment you need a shed load of savings (over £150,000) before you pay tax on the interest because the best rates on instant access is around 0.65% and the Personal Savings Allowance is £1,000 for basic rate taxpayers. BUT the interest rates are expected to go up this year – probably 4 or 5 small increments, but upward they are going. If we see savings rates @2% then suddenly you are paying tax on unwrapped balances of £50,000. (£25,000 if you are a high-rate taxpayer).
Second – you are allowed to change what is in the envelope in the future. If you want to swap your cash ISA for an investment ISA in a few years’ time, or vice versa for that matter, you can do so. This can be really handy if you want to repurpose a savings pot because circumstances change. Some examples include saving to cover study/career break/business start up that becomes obsolete because you decide on a different route or cease an unexpected opportunity. Perhaps you have saved hard for a house deposit and then decide to rent in Europe because you met a great person who lives in Italy? Things change, but once an ISA always an ISA with the facility to switch up the contents of the wrapper to suit altered financial objectives.
There is a tax-exempt wrapper for children – Junior ISA and Lifetime ISA comes with a 25% government bonus on a small portion of the overall ISA allowance if you commit to some restrictions on how you can use the LISA fund. For details use the links in the table.
Dividends are the distribution of profit to shareholders of a company. If you own shares, you can receive dividends and the first £2,000 of this income is tax free.
Some people set up their own companies and because they own the shares they can give themselves dividend to use this allowance, but for the rest it is about owning an investment in a profitable company/or fund so that when they declare dividend distribution you can receive it tax free within your allowance.
Obviously if you have popped your shares/fund into your ISA envelope (see above) the dividend is tax exempt, but if you own the shares/fund unwrapped then the dividend is potentially taxable (7.5% for basic rate taxpayers). You can deliberately select shares/fund for the dividend potential in order to extract some tax-free returns.
It is too late to set up an investment for this tax year, but you need to get on with selecting something ready for next year as dividends are usually announced six months in advance of being paid out. Only the shareholders at the time it is announced, will get the payment and often there are two payments per year.
There is a lot of choice when it comes to shares or a fund. It is less risky to buy a fund because you spread your investments across a basket of shares (diversification – the opposite to all your eggs in one basket) and you will be looking for funds which include “dividend” or “equity income” in the title.
A rule of thumb is 2 to 3% dividend yield on a fund designed to produce dividend income, but be aware that companies are not compelled to pay dividend and the rates change dependent on profitability, so it is all guesswork and estimates. At these rates however you could have £65,000 to £100k invested and fit the yield within the dividend allowance.
Capital Gains Tax
This one is often missed and yet it is one of those opportunities to be systematic about your tax planning and save a fortune. If an investment grows a few percent each year and that compounds up over time it can become pregnant with gain – let’s say you have a fund and it grows 5% a year over 10 years – you start with £20,000 and it becomes £35,817 (the power of compound returns – beautiful!) but if you sold out at this point you would land yourself a tax bill because only the first £12,300 would fit within CGT allowance and the bit that sticks out above the threshold gets taxed – So the gain above what was paid is £15,817 less CGT allowance makes a taxable gain of £3,517. For a basic rate taxpayer that would be 20% tax making £703 of unnecessary tax.
In the example above the investor could cash in part of the investment now and then wait to do the rest in the new tax year which starts 6th April and avoid the tax.
If you have unwrapped assets, then you should think about whether they are worth more than you paid for them and whether trading them to scrape off the gain within CGT allowance is a worthwhile exercise.
There are some rules you need to watch out for and trading things comes with costs, but this type of vision up tax planning can add many thousands to your wealth if managed systematically during your wealth creation journey. Check out the link in the table to access more details.
Use your ISA allowance to wrap an investment ideally, but if you only have cash available then wrap that.
Select a “dividend” or “equity income” fund to use your dividend allowance
Trade enough investments that are in profit to utilise your capital gains tax allowance
|Personal Savings Allowance||£1,000 or £500||It drops to £500 if you are a high rate taxpayer|
|Capital Gains Tax Allowance||£12,300||https://www.gov.uk/capital-gains-tax/allowances|