To follow is an interesting extract from a Citywire Money article published by Michelle McGagh on 15th February. Whilst you may already be aware of many of her suggestions, this is a useful read nonetheless.
Putting money aside is always a good idea, but putting your savings out of reach of the taxman will make your money go further.
Putting money aside for a rainy day is a great idea, but are you saving in the most tax-efficient way? Savers can benefit from a number of tax breaks and allowances, so make sure you’re making the most of them.
Most people squirrel money away in a bank or building society savings account, but the income – or interest – you receive from your savings is not tax free. The tax you pay depends on the tax bracket you fall into based on your earned income, but most banks take 20%, the basic rate of income tax, from your interest before you get it.
If you are a higher-rate taxpayer, paying 40% tax, you must pay the additional 20% via a self-assessment form.
Depending on the interest you’re earning, savings accounts may not be the best place to put your money, and you should make sure you take advantage of these tax breaks:
Individual savings accounts (ISAs)
ISAs are the best way to save in the UK. You can save cash or invest in stocks and shares through them completely tax-free up to £10,680 for the tax year 2011/12. Note that only half of this amount, £5,340, can be saved in cash: the rest must be stocks and shares. Or you can invest the full amount in stocks and shares.
The allowance will increase to £11,280 from April 2012.
ISAs should be your first port of call for saving because, unlike savings accounts, they do not incur any income tax on the interest on cash and there is no capital gains tax to pay on profits from investments. You will also escape paying any additional tax on dividends paid out by investments above the initial 10%.
Each person is entitled to one ISA, you must be over 18 to have a stocks and shares ISA or over 16 to have a cash ISA. You cannot have joint ISAs – they must be held in individual names.
Like savings accounts, ISAs offer different rates of interest, and the longer you tie your money in for the better the interest rate will be. If you want to be able to access your money easily then don’t expect a good interest rate.
Junior ISAs
Junior ISAs are a tax efficient way to save money for children. The Junior ISA replaced the child trust fund in 2010 and much like the adult ISA, there are cash or stocks and shares options. Only £3,600 a year can be saved into a Junior ISA, but all interest on cash, income from dividends and gains on investments is tax-free.
Pensions
If you are saving for your future rather than for the short term, a pension could be the best option. The government is so keen for you to save into a pension it offers you tax relief on all contributions you make.
If you are a basic-rate taxpayer you will automatically receive 20% tax relief on contributions, and higher-rate taxpayers earning 40% get 20% tax relief automatically but have to claim back the other 20% via a self-assessment tax return.
Note that this only applies to those paying into a personal pension – if you are paying into a pension set up by your employer the full 40% tax relief is automatically given.
Tax relief is essentially free money from the government, but you can’t put it in your pocket – it goes into your pension and you can’t take the money from your pension pot until you retire.
Capital gains tax exemptions
If you sell or give away an asset or receive money from an asset – assets in this case being investments, shares or even second homes – you are liable to pay capital gains tax.
However, to make investing more attractive, you are permitted to make a gain of up to £10,600 in the 2011/12 tax year that is exempt from tax.
For gains over this amount there is a flat-rate tax of 18% if you are a basic rate taxpayer and 28% if you are a higher-rate taxpayer. There are a number of tax breaks and costs you can offset against your gain as well, and you can offset any capital gain losses from the previous year against current gains.
As an added bonus, if you are married or in a civil partnership you can transfer assets to your spouse without paying capital gains tax, and they can use their capital gains tax allowance to reduce the tax bill further.
Investment bonds
Investment bonds are not as tax efficient as the other options on this list, but deserve a mention as they allow you to take some income tax free every year.
When you put your money in an investment bond it is then invested in a number of funds (that will hopefully increase your original sum).
Investment bonds are not for those who want to save a couple of pounds each month or who don’t want to lock their money away. Quite often you must invest at least £1,000 and be willing to tie the money in for a fixed amount of years or risk a penalty if you take it out early.
Although the insurance company that you buy the investment bond from pays the 20% tax from your pot of money, you are allowed to take an income of 5% each year from the bond tax free. The 5% is cumulative so if you don’t take your tax free income in one year, you can take 10% the next year. As the 5% is deemed “return of capital”, income tax is deferred on this money until 20 years when there is obviously no longer a tax deferred benefit (20 years x 5% = 100%).
For help with your savings and investments contact us on 01273 321223 or at wealth@paradigm-capital.co.uk.
The information contained is targeted at consumers based in the UK. It should not be taken as advice or guidance, and Paradigm Capital Limited does not guarantee the accuracy or content provided. If you wish you to receive financial advice, please contact Paradigm Capital as above.