Ben Yearsley: How can you reduce the Treasury's take?
Saturday 13 March 2010
With less than two months to the probable election date, the outcome is still up for debate. The polls indicate a hung parliament, but a majority result remains a possibility. One thing is certain, though: this country is in a pickle. A budget deficit of 13 per cent of GDP has to be paid for somehow, and there is only so much extra borrowing the gilt market can take.
So ignore the current rhetoric: both major parties would raise taxes and cut spending in their post-election Budget. I also wouldn't be surprised to see income taxes rising and, for some, the abolition of higher rate tax relief on pensions.
In short, things will be tough, and anything you can do now to reduce your taxable income and boost your tax-free income could be extremely valuable. So what are your options?
The first place to start is the individual savings account, or ISA. There are two types, cash ISAs (for those preferring safety) or stocks and shares ISAs. Over-fifties can currently put £5,100 into each annually, and for under-fifties the limits are £3,600. Alternatively, you can invest the combined allowance in just the stocks and shares component.
Many people underestimate the importance of ISAs. While rates on cash ISAs might look tiny today, what happens if interest rates go to 10 per cent in a few years? A larger tax shelter could become valuable in maximising the interest you receive.
It is similar with stocks and shares. With income of 4 per cent per annum from an equity fund and 5 per cent from a bond fund you could be receiving a valuable income stream that doesn't need to be declared on your tax return and doesn't affect any age-related allowances.
Even those of modest means should consider investing in ISAs. Investing £100 a month at 7 per cent annual growth gives you a pot of approximately £17,000 after 10 years.
Remember, if you don't use your ISA allowance you lose it, and you now only have three weeks to make use of this tax year's allowance.
Pensions are also an excellent, tax-efficient means of saving, as tax relief is usually provided at your highest rate. If you are a basic rate taxpayer, basic rate tax relief is paid into your pension and higher rate taxpayers receive higher rate relief from a combination of this and repayment via a tax return. Furthermore, everybody under 75 (children included) is entitled to invest at least £2,880 into a pension each year and have £720 tax relief added – even non-taxpayers and those who aren't employed. Investment choice is similar to that of an ISA, so you can still pick the level of risk you want.
Whilst pensions are tax-efficient, their aim is to produce an income in the future which is taxable, effectively the opposite of an ISA, where you invest using taxed income but you receive tax-free income back. There is a long-running debate about whether ISAs or pensions are preferable in this regard, and I have no intention of settling it now. All I will say is that having both is sensible for most people.
For more adventurous investors with ISA and pension provision in place, Venture Capital Trust and Enterprise Investment Scheme are further "use it or lose it" allowances. With VCTs you can invest up to £200,000 per tax year and receive up to £60,000 back as a tax rebate. With the EISs, you can invest up to £500,000 per tax year and get back up to £100,000. The catch is they invest in small, sometimes embryonic, companies, so the level of risk is high. You are also tied into a VCT for at least five years, and at least three years with an EIS. All gains on VCTs and EISs are tax-free, as are dividends from VCTs. However, I would emphasise that whilst ISAs and pensions are suitable for the majority of investors, VCTs and EISs are only suitable for a minority.
Whatever your ability to save and attitude towards risk, there is a tax-efficient investment available. In the future there will be greater reliance on self-provision in retirement, so using your ISA and pension (and possibly VCT and EIS) allowances could be worthwhile in the longer term.
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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