Using your annual allowances effectively is an important part of a coordinated financial planning strategy in any typical year. A high tax burden, alongside the cost of living squeeze, means it’s more important than ever to optimise your use of available allowances ahead of the end of the 2022/23 tax year. Staying on top of your tax situation as part of a robust and flexible financial plan can save thousands of pounds in the short term, and substantially improve financial outcomes over the long run.
Pension annual allowance
The standard pension annual allowance, which is the maximum amount that can be contributed into a pension and benefit from tax relief, is £40,000 or 100% of your net relevant earnings (NREs) up to the annual allowance. Contributions for non-earners are limited to a maximum of £3,600. Contributions into a pension can be particularly attractive for high earners, especially those earning between £100,000 and £125,140, who can receive an effective rate of 60% tax relief on their pension contributions.
Tip: Savers may be able to increase tax-incentivised pension contributions by carrying forward unused annual allowances from the three previous tax years. You must use the annual allowance in the current tax year first, before using carry forward from prior years. Depending on their previous annual contributions and current income tax liability some savers may be able to contribute a possible £160,000. However, carry forward from 2019/20 has to be used in the current tax year, or it will be lost forever.
ISA annual allowance
You can pay a maximum of £20,000 per year into an ISA (or £40,000 if a couple were to use both their allowances). It’s always prudent to maximise stocks and shares ISA contributions before paying into a general investment account, as investment gains are free from income tax and capital gains tax, and the annual allowance can’t be carried over.
Tip: Paying into an investment ISA at the start of the tax year, rather than the end, allows you to fully benefit from the ‘snowball effect’ of compounding returns.
Capital gains ‘harvesting’
Capital gains tax is a tax on the profit when you sell, or dispose of, an asset that has increased in value. This includes investment portfolios where basic rate taxpayers pay 10% tax on their investment gains, while higher and additional rate taxpayers pay 20%. Each adult currently benefits from a capital gains tax annual exempt amount of £12,300, although this is set to be cut to £6,000 from April 2023, and to £3,000 in April 2024.
Tip: By applying your annual exempt amount in each tax year you could be able to make significant tax savings, in contrast to deferring capital gains on investment accounts and facing a larger tax bill in the future.
ISA vs. pension considerations
Making full use of available allowances allows you to optimise your finances and save on taxes, leaving more money to spend on what matters most to you.
Tip: It’s important to consider the interplay between pensions and ISAs, as there are some key differences. For example, pensions do not form part of the estate for inheritance tax (IHT) purposes, whereas ISAs may be subject to IHT, unless left to a spouse/civil partner. ISAs can typically be accessed flexibly, unlike pensions, which are ringfenced until you reach 55 (57 from 2028).
Effective use of tax wrappers and allowances forms the backbone of a robust financial plan. To find out more call the Lumin team on 03300 564 446, or get in touch via our contact form.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
