Take steps to ease the pain of our taxing times
THERE'S no escaping it - wherever you look, taxation is lurking around every corner. The economy has been going through fiercely challenging times and now we all have to pay for the remedies.
While high earners will bear the brunt of new taxation measures, it is not just the wealthy few who will be affected – the middle-income bracket will also be in the line of fire from next year.
Nevertheless, those on higher incomes are likely to see their personal wealth impacted through increased tax liabilities. From April, those with incomes over £150,000 will have to share their income over this level on an equal basis with HM Revenue & Customs (HMRC) though their income tax liability.
What is more, those people with an “adjusted net income” of more than £100,000 will suffer an effective rate of 60% on income between £100,000 and £112,950 because of the erosion of their personal allowance.
Higher earners, therefore, are looking at ways to ease their liability. And by carefully working out lifelong cash flow requirements, it is still possible to maintain a desired lifestyle and sustain wealth during retirement – with careful planning.
There remain a number of tax mitigating solutions that are worthy of consideration. Retirement planning is one, and setting aside funds for retirement is critical for everyone – and you can still make the most of your pension as a tax-efficient investment.
Tax relief on pensions has been restricted since April 2009, mainly affecting those with total incomes of £130,000 or more. But even with new restrictions being introduced by HMRC, the tax relief available to pensions is unique and generally remains generous and attractive. Maintaining existing pension contributions is still a practical option for keeping tax bills down in 2009/10 and 2010/11.
Even if you have tax relief restricted to 20%, pensions can still be the most effective way of investing for retirement, even if you are likely to be a higher rate tax- payer when you retire. This is because you will still have a significant part of your retirement income taxed at basic rate (£37,400 at 2010/11 tax rates) plus the personal allowance if your total income is less than £100,000. This means that, depending on other sources of income, a significant portion of your retirement income may be taxed at basic rate.
Salary sacrifice is a tax-efficient way of increasing your pension contributions and keeping most of what you earn. Changes in the way HMRC treats salary sacrifice, together with the reform of pensions legislation four years ago, have made salary sacrifice more attractive particularly to those with total income under £130,000.
If the employee waives the right to receive part of their salary or bonus then the portion that is waived is no longer treated as earnings and therefore not subject to Income Tax, or National Insurance Contributions.
However, as pension contributions start to become less tax efficient for higher earners, other options can be explored. High earners can maximise their contributions to ISAs (Individual Savings Accounts), for example.
ISAs represent the most tax-efficient way to save and invest for the future. And their tax efficiency and flexibility has even greater value as taxes rise across the board. They are easily accessible, withdrawals are paid with no tax liability, they are a useful short or medium term account for cash, and offer an easy route to the equity markets. And from April, the annual ISA allowance increases from £7,200 to £10,200 for all eligible investors.
The full allowance can be invested in a stocks and shares ISA or alternatively, up to £5,100 of the allowance can be saved in a Cash ISA. The higher allowance is already available to those aged 50 or over in this tax year.
Other tax-efficient savings vehicles include VCTs (Venture Capital Trusts) and EISs (Enterprise Investment Schemes). These exciting investment opportunities can offer significant tax benefits, such as income tax relief, tax- free growth, deferral of capital gains tax (CGT) and tax relief when funding for retirement and inheritance tax mitigation after two years.
As the underlying investments are usually held in very small UK companies, there is a risk that these investments may not perform as hoped and in some circumstances may fail completely, so they do have a higher level of risk.
High earners should also consider carrying out a review of tax arrangements, making sure that any investments are held in the name of the lowest taxpayer, and set up trusts to make sure income is passed to other family members. In addition, anyone planning to surrender a life insurance policy should consider doing so before April 5 while the top tax rate is still 40%.
They should also consider holding investments that are subject to CGT, where the maximum tax is only 18%; obtaining the benefit of the profit on investments with a big CGT liability and reinvesting the proceeds before March will have advantages.
Additionally, consideration could be given to deferring claims for income tax relief until April 2011 when the relief will be available at 50% instead of 40%. And if bonuses or dividends can be taken before April 5, these will be taxed at the current lower rate.
The financial needs of people who have created more capital or who earn higher incomes than average are invariably more complex than most. A personal wealth management service with a trusted specialist helping to understand and explain the issues, as well as propose bespoke solutions, will go a long way to help high earners remain as tax efficient as possible.
David Cook, director of ACA Financial Services, Sunderland
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