The Wire: Summer 2021 – Key planning takeaways signalled by ‘Tax Day’

(Estimated read time 5 minutes)

Key planning takeaways signalled by ‘Tax Day’

The lead up to 23 March 2021, otherwise known as “Tax Day”, brought with it an abundance of speculation regarding extensive tax reforms set to curtail the amassing debt from the pandemic. The actual day itself was rather underwhelming in the shadow of this speculation, with minimal immediate changes being implemented.

The chancellor was clear that no one’s take-home pay would rise due to his policy announcements. However, his earlier Budget saw the introduction of changes that will likely impact financial strategies across the spectrum. These changes have been referred to as “stealth” taxes within the press.

This article will look at three of Rishi Sunak’s key announcements and how they might impact your family’s planning strategies.

Lifetime Allowance

As a recap, the Lifetime Allowance is, in its simplest form, a limit on the amount of pensions savings you can accumulate over your lifetime.

The allowance was first introduced in 2011, with a limit of £1.8 million. Over time this has reduced, until the 2016/17 tax year where it saw its lowest level of £1 million. Since this date, the allowance has been increasing with inflation each year.

The practical application of the Lifetime Allowance is complicated, ultimately relying upon an individual triggering a “benefit crystallisation event” (BCE), of which there are thirteen. The most common are; drawing benefits from your pension and two forced events at your 75th birthday and upon death.

If you are found to have exceeded the Lifetime Allowance at one of these BCEs, you will trigger a tax charge. The charge is 55% on savings above the allowance if you take them as a lump sum or 25% if you take or defer them as income. Note that you will also be subject to income tax upon the subsequent withdrawal of benefits where you opt for the lower charge.

Rishi Sunak’s announcements saw the Lifetime Allowance frozen at its 2021/22 tax year value of £1,073,100 until 2026.

From the Exchequer’s perspective, the freeze raises money in two ways:

  • Investors could reduce their pension contributions, which saves the government money in tax relief.
  • Investors could breach the Lifetime Allowance and therefore pay additional tax charges.

For those of you that are at or approaching the Lifetime Allowance, this will be more immediately pertinent than those that are not. However, this announcement could still impact your future strategy for those of you not currently near the Lifetime Allowance.

Analysis by Canada Life shows that a current pension pot worth £351,000, with ongoing contributions of 10% a year from someone earning £80,000, could breach the Lifetime Allowance in 20 years if the allowance is frozen until April 2026 and then increases by 2% on average each year after that.

So what does this mean, and should you still contribute to your pension?

In short, the answer to this will depend upon how your pension fits into your existing financial strategy.

The crucial point I want to stress is that just because you will breach the Lifetime Allowance does not mean that paying into a pension is bad — especially where this relates to a company pension, where your employer will match your contributions.

To find out if it is still in your best interest to contribute to your pension, you would need to analyse the net cost of contributing vs. the likely net sum you will receive in the future and then consider this in the context of alternative saving options that are available to you, such as ISAs.

Ultimately, approaching or breaching the Lifetime Allowance should prompt you to review your savings strategy to see if there may be a more efficient solution to meet your future needs. In addition, you should also review your investment strategy, as the risk reward profile of any future growth changes where you know part of that growth will ultimately go to HMRC.

Inheritance Tax

Since 2009, Inheritance Tax (IHT) has been payable on estates valued at more than £325,000 – the “nil-rate band”.

In 2017, an additional allowance – the “residence nil-rate band” – was introduced, which currently increases the threshold at which Inheritance Tax is paid to £500,000 for an individual and £1 million for a couple. To qualify for this additional allowance, you must leave your home to direct lineal descendants.

In the March Budget, the chancellor froze these thresholds at the current level until 2026.

Even without the freeze, more and more people have seen their estate’s value rise above the thresholds in recent years thanks to booming property prices and strong investment growth.

Now, the Office for Budget Responsibility estimates that more than 36,000 estates a year will pay the death duty by 2026, up from fewer than 25,000 in recent years. The freeze is estimated to raise almost £1 billion for the government.

Much like the Lifetime Allowance, the impact and potential solution to this change will depend upon your existing financial strategy and the wishes you have for your estate.

However, as we have touched on in previous articles, there are ways you can help mitigate any potential tax liability on your estate through careful planning. Some of these solutions include:

  • Spending more money on the lifestyle you love
  • Making gifts to your family now, so you can see them enjoy themselves during your lifetime
  • Establishing a charitable foundation or making gifts to charity
  • Establishing trusts to create a legacy in which multiple generations of your family can benefit
  • Altering your investment strategy to exempt asset classes
  • Prefunding your Inheritance Tax liability using an insurance policy.

There is no “one size fits all” approach to mitigating Inheritance Tax, and taking professional advice can really help. Read this useful case study for some ideas of how we helped one family mitigate a significant tax liability.

The announcement in the Budget should prompt a review of your legacy planning strategy to ensure that any existing plans will provide for your beneficiaries as you intend.

Capital Gains Tax

Lastly, Rishi Sunak announced that the Capital Gains Tax (CGT) annual allowance would be frozen at £12,300 until 2026.

Given the speculation in the lead up to both the Budget and Tax Day, this was probably the best outcome we could have hoped for. It was widely anticipated that Rishi Sunak would align CGT and Income Tax rates, meaning higher- and additional-rate taxpayers could have ended up paying 40% or 45% on capital gains.

The freezing of the CGT allowance may seem insignificant compared to the previous taxes we have discussed. However, it is essential to remember that you can’t carry forward any unused CGT exemption.

By having an efficient tax strategy in place, like using your CGT allowance each year, you could be saving yourself up to £2,460 in tax each year (20% of the CGT allowance). While this may not seem like a lot, using this allowance each year, along with compounded investment returns, the savings can soon add up, providing extra funds for those post-pandemic activities you’re waiting to do.

If you don’t have a tax planning strategy already, you should create one, and if you do, you should review it in light of these recent changes.

Looking forward

While Tax Day allowed some sense of relief compared to the speculation ahead of it, we should still be conscious that the government could still make changes in the future.

It is worth noting that, speaking at the Wall Street Journal’s summit in May, Rishi Sunak praised the UK’s “progressive” tax system and the tax contribution of higher earners. It is the first time the chancellor has provided any level of comfort that tax increases are not imminent, so this should provide much-needed reassurance to individuals and businesses.

As with any planning, the continued review is crucial. If you already work with a financial planner, then be sure to review your strategy with them, and if you don’t, we welcome the opportunity to offer a helping hand to help navigate the complexities of making your money work for you.

Download PDF
Print Friendly, PDF & Email