Tax Year End Planning 2024/25 - Top Tips Part Two - Pensions

Pensions needs its own blog topic, and there are two reasons why.

Firstly, because pensions have been messed about with so much that allowances and rules are different for different people, so we need to cover a few different examples.

And second, because pensions can be an incredibly good way of saving for retirement and making your income more tax-efficient now, so it needs the time and space to properly explain the tips to achieve that.

This is a more technical post, which is unavoidable, as there is a fair amount of tax to cover. But, as ever, we will try to speak in plain English and not lose you along the way!

Why put money into pensions?

Let's start with the obvious - pensions are designed to build funds ahead of retirement. Most of us aren't saving enough for retirement, so as the most basic of reasons, pensions do this well.

Over and above this, they can also can be incredibly valuable as a tax-planning tool for you now.

That mind sound a little odd, given that pensions are designed as a savings tool for later on.

They do this, however, through two key tax-efficiency features:

1. Tax relief at your highest tax rate
   

2. They reduce your income for the year to provide your 'adjusted net income'.

Tax Relief

If you make personal contributions to a pension, you'll get basic rate tax-relief automatically applied.

Let's take an example of contributing £8,000 in to your pension. It'll look like this:

Hey presto, £10,000 goes into your pension.

Hopefully to grow in the years ahead before retirement. Growth on the money you put in, and growth on the tax relief part.

Higher Rate tax-payers

If you're a Higher Rate tax-payer, you can also claim back a further £2,000 in tax relief in your tax return.

You'd therefore get £10,000 in your pension, plus £2,000 back, meaning it has cost you £6,000 to put £10,000 into pension.

Additional Rate tax-payers

If you're in the 45% tax bracket, you'll get the £2,000 immediate tax relief, just like basic rate and higher rate tax-payers, but you'll get £2,500 in your tax return.

But remember, you do need to claim it, it won't happen otherwise!

Some warnings on limits and allowances

Just be careful that you are limited to £60,000 annual allowance of contributions. This limit includes personal contributions, tax relief automatically applied and any employer pension contributions.

You also need to be careful that you do not contribute more than your earnings to pensions in any given year. If you do, you won't receive tax relief on the amount over your total earnings.

For those with total income over £200,000 your annual allowance of £60,000 may be tapered down, so you need to be really careful working out how much you can put into pension. This is something we can help you work out.

Reducing your 'net adjusted income'

Another reason pension contributions can be valuable, is that some types of contributions have the effect of reducing your income in the year contribute.

Making pension contributions means you end up with a lower 'adjusted net income'.

In plain English, this simply means reducing how much of your income is taxable. This is one of those pension tips that not a lot of people know about.

Our tax system is a little odd, so don't worry about the terminology, just know that bringing down your total income through pension contributions can be a big help.

So, which are the situations it can be valuable?

60% Tax Trap

For those people earning above £100,000, there could be a significant benefit to putting money into pension, as otherwise you'll be paying tax at an effective 60% rate on a chunk of your income.

This occurs because of the tapering of the Personal Allowance. The Personal Allowance is the amount of income you can earn before paying income tax, and is gradually reduced once your income exceeds £100,000.

For every £2 of income above this threshold, your Personal Allowance is reduced by £1. This effectively results in an additional 20% tax on income between £100,000 and £125,140 (for the 2023/24 tax year), on top of the usual income tax rates.

As described in the 'child benefit' and 'higher and additional rate taxpayer' sections above, if you can reduce your adjusted net income down below £125,140, you will start making some serious tax savings.

Meet Jenny

Jenny earns £130,000 from her job working as a programmer. She doesn't need all of her income, and is happy saving some for retirement.

On current (2023/24) tax rates, she'll take home £79,932.40 over the course of the year.

For ease, let's call it £80,000. This works out to be £6,666 a month.

That means she's paying £50,000 in Tax and NI, or an effective tax rate of 38%. Ouch.

If Jenny instead puts £30,000 into her pension, it gets topped up automatically by tax relief to £37,500. She can then claim a further £7,500 back in her self-assessment tax return.

The effect is that her 'adjusted net income' for the year is £100,000, and because of this, she regains her Personal Allowance.

She'll take home £67,803 instead of £80,000. Meaning take-home pay of £5,650 a month, around £1,000 less than when not making pension contributions.

Looking at it visually may help.

Look how much of the picture is red (tax) in the top line, with no pension contribution being made.

The red section is a lot smaller in the second line, with other benefits compensating for the loss of some take-home pay, such as tax back from her self-assessment return and money going into pension to save for retirement.

Child Benefit

If you've got children under 16 and you (if you're on your own), or you and your partner/spouse, have income of £50,000 a year or less, you should get full child benefit.

If one of you, or both of you earn over this, the benefit tapers down, until one or both of you earn over £60,000, and then you effectively get nothing, as it all gets paid back in tax if you claim it.

The rules actually state that the benefit payment is assessed on your 'adjusted net income'.

Lets say you earn £55,000 salary and have a child. As is stands, you'll lose half your child benefit allowance, meaning you'll miss out on £624 a year.

If you were to put £5,000 into pension as a personal contribution (not via work payroll), the government would add £1,250 as tax relief, so £6,250 would go into pension.

Your adjusted net income would reduce to £50,000 and you would get back all of your child benefit allowance. So you would get:

• £624 back in child benefit

• £1,250 tax relief into your pension

• An extra £946 tax relief to claim back via your tax return as higher rate tax relief.

Total of £6,250 saved for retirement, with an extra £1,570 back in child benefit and higher rate tax relief.

That's £7,820 total benefit from £5,000 of your money.

Action - see if making a lump sum pension contribution would make a difference to your tax position, but only if you can afford to do it!

Some things to be aware of:

• When making contributions, you need to be aware of the annual allowance rules

• If you have income of over £200,000 you may be subject to the tapered annual allowance

• All of the examples above are based on making personal contributions, that is contributions not through an employer pension or through a business.

• If making contributions through your workplace pension or as an employer contribution through a business, the calculations change and we'd be happy to discuss these with you.

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See! pensions can be a lot more interesting than on the face of it.

No? just me? well, you can't say I didn't try!

If you'd like to help with pensions and making your income more tax-efficient and work harder for you, come and book in a chat here:

https://calendly.com/labfp/intromeeting

Otherwise, see you next time.

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The information contained within this blog post should not be taken as financial advice, as it does not take account of personal circumstances, which would affect advice given. Should you wish to talk to us about personalised advice for you, we'd be happy to do so.

Tax rates are based on the tax year 2023/24.

Tax Year End Planning 2024/25 - Top Tips Part One - ISAs, LISAs and CGT

Being tax-efficient is important, especially with the compounding effect of getting into good habits every year. It falls into the category of 'really quite dull, but necessary'.

A lot of your allowances are 'use it or lose it', so it pays to give it a little bit of thought now, then you can forget about it again in April.

This post covers a few of these allowances: ISAs, LISAs and Capital Gains Tax, and it's mercifully relatively short and sweet. Giving you the tools to cover off your tax year end planning.

We will be releasing a post all about pensions next week. That needs its own post for two reasons, which will be explained then.

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Anyway, back to ISAs, LISAs and CGT, and remember, 5th April is the cliff-edge date you need in mind, before we roll into the new tax year.

ISA

Individual Savings Accounts (ISAs) allow your savings to grow free of income tax and capital gains tax. Additionally, there is no tax to pay on withdrawals from them, making ISAs a great option for long term savings and providing future flexibility to fit around your plans.

The ISA allowance for this year is £20,000 per person, and there are various types of ISA available – with the main two being Cash (usually better for shorter term savings or those who are very cautious with their money) or Stocks & Shares (for longer term growth).

The simple difference between the two, is that a Cash ISA will offer you a fixed rate of return, which is usually below the rate of inflation. So in effect you are often getting a 'real-terms' loss, but getting some interest on your money at least.

With a Stocks and Shares ISA, there is no guarantee of a return at all, and your fund may fall in value. But, depending on how you invest, and how well that investment performs, you can receive a 'real-terms' return, meaning your money grows above the rate of inflation. 

A common misconception with a Stocks and Shares ISA is that you have to invest in individual company shares. Whilst you can do this, you can also invest in funds, which combine dozens, and sometimes hundreds, or even thousands of holdings in them, much like the funds you will be invested in through your pension.

Something not a lot of people know about ISAs, is that they can be transferred back and forth between Cash and Stocks and Shares in future years, without using up any of that year's allowance. Handy if you want to grow your money now by investing in a Stocks and Shares ISA, but then move some or all of it to a Cash ISA in the future, perhaps near the time you need to use the money and don't want to take risks with it.

Likewise, if you like the idea of the tax-efficiency of ISAs, but don't feel comfortable taking risk with the money yet, or are in a rush to put it in before the end of the year, you can put it into a Cash ISA, in the knowledge you can transfer it to a Stocks and Shares ISA at a later date.

Why use ISAs?

ISAs are brilliant as a store of tax-free funds to be used flexibly in the future. Most will allow for regular withdrawals, or lump sums to be drawn out.

Some providers also offer a 'flexible ISA', which means that if you draw out during a year, you can put back the amount you've withdrawn, as well as the usual contribution allowance.

Along with pensions, ISAs are one of the most tax-efficient options for your money.

They can be utilised incredibly effectively along with pensions, when you think about the timeline you can access them both. ISA access is immediate, pension will be from age 55 for some, and age 57 for others.

If you save into both and ISA and pension, both should ideally be saved for the long-term, but you can access your ISA funds any time, should something crop up before retirement.

LISA

If you're saving for your first property purchase and under 40, its worth considering a Lifetime ISA (LISA) too.

Why? Because the government will put in a 25% bonus on whatever you contribute.

I hasten to use the words 'free money' because you've almost certainly paid tax somewhere along the lines to have that money to contribute, but it's about as close as you're going to get to free money.

You can put up to £4,000 a year into a Lifetime ISA, and whatever you put in, uses up that much of your total ISA allowance of £20,000.

Putting in £4,000 into LISA will give you a £1,000 bonus from the government.

You can leave both the investment and bonus money in cash, or invest it to try and grow it. Which approach is right for you will depend on how soon you want to buy a property.

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If you've already bought your first property and are under 40, you can still open a LISA, and use it for retirement instead.

You can contribute until age 50, and draw from it from age 60.

Under current rules, if you draw from it before age 60, you'll get a 25% penalty on whatever you draw out.

Lets say you contribute the maximum of £4,000 each year from age 35 to 50.

You'll put in £60,000 and get £15,000 in bonuses added. Giving you £75,000 in the fund.

If invested, that £75,000 fund could grow very nicely after 25 years, at which point you can draw from as you please, either in lump sums or regular income as part of your retirement plan.

Why use LISAs?

Helps provide additional bonus funds if you're looking to buy your first house, or saving for retirement, and funds grow, and receive income, tax-free whilst held in them.

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Capital Gains Tax (CGT)

If you've got investments that are liable to CGT, such as investments in General Investment Accounts (GIAs), it may be worth considering using your CGT allowance to realise the gains you've built up.

The CGT allowance is £6,000 per person, reducing to £3,000 per person next year, on a use-it-or-lose-it basis.

A popular strategy is to sell down some holdings to be able to then put them in your ISA, thereby using your CGT allowance and placing more in the tax-free ISA for the investments to grow tax-free.

Instead if they remained in the GIA, they would be taxable when you come to sell in the future, with a lower CGT allowance as well, meaning more tax to pay.

Equally, if those funds provide dividends or interest, that is taxable when held in a GIA, but not when held in ISA.

If you've made losses in previous years that you've realised, these can be carried forward and added to your CGT allowance for this year.

Why use the CGT allowance?

Because it allows you to realise gains each year, thereby reducing the total tax you should pay over the lifetime of an investment.

Plus, the allowance is halving from April, and it is a use-it-or-lose-it type deal.

Action - see if you can take advantage of any of these allowances before tax year end.

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Being tax-efficient isn't exciting, but making your money work harder for you so that you can do more of the things you want to do, that is exciting.

If you'd like to talk to us about providing you with personalised financial planning to help with this, you can book in an initial consultation here:

https://calendly.com/labfp/intromeeting

Otherwise, see you next time.

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The information contained within this blog post should not be taken as financial advice, as it does not take account of personal circumstances, which would affect advice given. Should you wish to talk to us about personalised advice for you, we'd be happy to do so.

Tax rates are based on the tax year 2023/24.

What should I do with my company profits?

For some business owners, it's the perennial problem, what do you do with excess company profits?

First, just like with your own personal finances, you always want to have a capital float for planned, and unplanned, large expenditures. That goes without saying for good planning.

So let's assume you have that in place, and that you don't need to re-invest in the business.

What do you do with the rest? and with the expectation that this will crop up again every year?

You've got four choices:

1. Leave it in the business bank account.
   

2. Put it in a business deposit account.
   

3. Invest it in a corporate investment.
   

4. Put it into your pension.

Let's take each in turn.

So now we know this, let's talk strategy.

Company profits - Strategy One

Some business owners intend on leaving excess profits in the business, and then plan to withdraw the cash when they sell the business, and benefit from a reduced 10% Capital Gains Tax rate, due to Business Asset Disposal Relief (BADR), which used to be known as Entrepreneur's Relief.

For most businesses, this is a viable option. But if you do go down this route, you still need to know what you will do with the cash in the meantime. In which case, you'll need to decide between options 1, 2 or 3, or a blend of these options.

Company profits - Strategy Two

Most business owners hate paying more tax where possible, you already get taxed a lot right?

Because of this, some business owners instead fund their pension as much as possible each year, primarily due to the tax efficiency of employer pension contributions being an allowable business expense, and thereby reducing the amount of profits liable to Corporation Tax in the first place.

The added upside? it diversifies away your own personal wealth from the business.

If you were planning on a nice big sale valuation when you come to retire, it's a lot stressful extracting the value you think you're owed if you have a healthy pension to fall back on.

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Let's play out the two different approaches/strategies with an example business owner.

Patrick, is aged 45, and owns PR123 Ltd., a PR company, which make profits of £100,000 a year after all staff remuneration. He likes to take £40,000 dividends a year to top up the salary he pays himself.

Approach One & Two Compared

What are the differences?

He has more left in the business in Approach One, however, he's paid £13,250 more in Corporation Tax for the privilege.

In Approach Two, he has put £50,000 into his pension, hopefully to grow ahead of his retirement, plus left £500 in the business.

In both cases, he's taken out the dividend he wanted.

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What does the long-term picture look like?

After 10 years, he'll have put £500,000 into his pension in the pension scenario. He'll have paid £95,000 Corporation Tax.

In the no pension scenario, he'll have £377,500 in the business bank account, and paid £227,500 in Corporation Tax.

So on the face of it, leaving the money in the business is a bad idea.

But what about what compounding does to the money after 10 years, and what about the tax you would pay on getting the money out of the business, or out of the pension?

Let's look at three scenarios:

1. He gets no growth on the money in the business bank account - he simply leaves it in the same bank account and does nothing with it
   

2. He moves it around attains a 4% return/interest each year in a business deposit account.
   

3. He invests it in the pension and gets a 4% return each year.

Scenario 1:

Patrick builds up £377,500 in total, then pays 10% Capital Gains Tax and takes it all out as a lump sum, and gets £339,750.

Scenario 2:

Patrick builds up £471,360 in total, which is the same £377,500 as in Scenario 1, but with added interest at 4% a year.

He'll then pay 10% CGT and get £424,224 out.

He's ultimately got around £95,000 more out by making sure he's got a good level of interest/return in those 10 years with the retained profits.

Scenario 3:

Patrick builds up £624,318 in his pension.

If he took his pension out as income under UFPLS rules (which means he'll take a bit of tax-free cash income with each taxable income payment), and he is a basic rate tax payer in retirement, Patrick will pay an effective tax rate of 15%.

Because of this higher tax rate on a higher amount of capital, he'll pay more in tax - £93,468 - but he'll get £530,670 out over time.

By far and away, the highest level of drawing from the business overall when compared with the other two scenarios.

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What do I do now?

It is clear from the figures that putting excess profits into pension is the most tax efficient route for most business owners, and even more so for those businesses who do not qualify for BADR when they sell, such as some companies involved in property.

If you put money into pension, you need to work out how to invest it and how much risk to take.

You also need to be aware that you won't be able to draw it all out as one lump sum at retirement without being heavily taxed.

Whereas if you take it all out as a lump sum from the business at the point of sale, you then need to decide what to do with it. For some people that flexibility is useful, for others it proves a challenge to work out where to put it, to provide the required income for whatever comes next, probably retirement.

Action - work out whether you would prefer to keep it in the business or put it into a pension. Either way, you need to make sure it is working for you and is growing or earning interest!

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We help lots of Business Owners be tax-efficient and plan for the future, be it post-exit or retirement.

If you'd like to talk to us about providing you with personalised financial planning to help with this, you can book in an initial consultation here:

https://calendly.com/labfp/intromeeting

Otherwise, see you next time.

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The information contained within this blog post should not be taken as financial advice, as it does not take account of personal circumstances, which would affect advice given. Should you wish to talk to us about personalised advice for you, we'd be happy to do so.

Tax rates are based on the tax year 2023/24.