The end of the tax year is a good deadline to give investors the hurry-up to sort out their finances or risk missing out on potentially lucrative loopholes.
Readers of Trustnet have mixed views about the end of the tax year. According to our survey, around 44% plan to invest in their ISA before April, either in one lump sum or as part of an ongoing savings plan.
The remaining 56% however said they were not, with 30% of respondents noting that they had already reached the full ISA allowance.
But the ISA is just one way that investors can get their finances in check. Below, Laura Suter, head of personal finance at AJ Bell, outlines a checklist for savers to make sure they have maximised their finances ahead of the new year.
Pensions
Although most of us only think about the tax we pay in, there are a few ways that savers can get free cash from the government. One way to do this is through their pension.
Pensions benefit from tax relief of 20% for basic-rate taxpayers, but higher and additional rate payers can reclaim an additional 20% or 25% tax relief respectively through their tax return, making it an “obvious place to start”, according to Suter.
“That means for a basic-rate taxpayer every £1 in your pension only costs you 80p and for a higher-rate taxpayer every £1 in your pension only costs you 60p,” she said.
The pension allowance for the year is £40,000, including contributions made by the saver and their employer.
“The annual allowance can be carried forward for up to three years, so investors should consider whether they have made as much use of their pension annual allowance as possible ahead of the end of the tax year,” she said.
People with multiple pension pots should also be a priority as it will give them a grip on how much they need to save for retirement, but also allows them the chance to combine them with the existing provider, making it easier to monitor.
“You could also benefit from lower charges, greater investment choice and more flexibility when you come to access your pot,” Suter said.
Cash and stocks & shares ISAs
While more than a third of our readers have already maxed out their allowance for the year, Suter said it was imperative that the 44% who have not tried to use as much of the £20,000 allowance as they can, both in a stocks & shares ISA and a cash one.
Investors with spare ISA capacity should also look to use a ‘Bed and ISA’ to funnel any investments from general investment accounts into the tax wrapper.
The process requires investors to sell and then re-buy any investments, however, which may incur capital gains tax on any profits, although they can use the £12,300 allowances to minimise this.
It is also important to note that the dividend tax is rising. Anyone that earns more than £2,000 in dividends will be hit harder next year, with the rate at 8.75% for a basic-rate taxpayer, 33.75% for a higher-rate taxpayer or 39.35% for additional-rate taxpayers.
This is 1.25 percentage points above last year’s rates and means someone with £10,000 of dividends outside an ISA will pay an extra £100 a year in tax as a result. Investors in ISAs meanwhile will be shielded from this higher tax.
Lifetime ISAs
For our readers who have spare cash that is not needed for the foreseeable future (and aged between 18 and 39), a Lifetime ISA may be a good option, although there are 25% exit penalties for early withdrawals before the age of 60 if not used for a house or pension.
Anyone using a Lifetime ISA can get up to £1,000 of free money from the government each year, if they put in the maximum £4,000 contribution.
Saving for children
Parents should also consider opening a Junior ISA (Jisa). The allowance is currently £9,000 a year, and children won’t be able to access the money until they are 18, at which point it automatically turns into a standard ISA and transfers into their name, giving them full access, Suter explained.
“If you contribute the maximum £9,000 each year and achieved a 5% investment return after charges each year, the pot would be worth almost £266,000 by the time your child turns 18,” she said.
However, for many families putting the full £9,000 into the pot isn’t realistic, particularly if they have more than one child.
Squirrelling away £50 a month (and assuming 5% returns each year), would give your child a £16,000 when they turn 18.
Parents could also save up to £2,880 into a Junior SIPP each year, with government tax relief automatically boosting that to £3,600, although children will have to wait longer – until they are 57 – to access it.
Have a savings goal
Setting up a regular investment plan and putting in a set amount each month will allow people to smooth out any short-term volatility and could even benefit investors in the long run from buying at the lower price, Suter said.
It is also important to set an investment account to automatically reinvest the dividends, unless needed for income, as this could “turbo-charge returns”.
“If you reinvest them, you can buy more shares in the same investment, which can have a dramatic impact on the size of your ISA fund over the long term,” Suter said.
The difference can be stark. As an example, someone investing the full ISA allowance of £20,000 and achieving a compound annual growth rate of 5% and annual dividend yield of 4% a year would have £53,066 in their ISA after 20 years and £26,453 in cash dividends: a total return of £79,519.
However, an investor who reinvests the dividends rather than banking them would have £112,088 – more than £32,500 extra, she said.
Avoid the high-rate tax trap
Some very high earners might wish to consider reducing their taxable income below £100,00 to keep their tax-free personal allowance, which for most people is currently £12,570.
“When your taxable income reaches £100,000, your personal allowance is cut by £1 for every £2 of your income, which means you lose it completely once your income reaches £125,140,” Suter said.
For example, someone who gets a pay rise from £100,000 to £110,000 will lose £5,000 of their personal allowance. There are two ways to reduce income. First is by making charity donations and second is by contributing to a pension.
Other things to consider
Some other ways investors can save money before the 5 April deadline include the marriage allowance and tax-free childcare, which gives a 20% top-up to parents, Suter said.
“In a similar way as above, people will start to lose their child benefit when one half of the couple earns more than £50,000 – and the benefit will be wiped out entirely when they hit £60,000,” Suter said.
“A parent with two children will get £1,828 a year in child benefit, but for every £1,000 they earn over £50,000 they will lose 10% of their child benefit – so someone earning £51,000 will lose £183.”
Like above, parents can consider higher pension contributions or charitable donations to reduce their tax bill, although these will need to be declared to HMRC on their tax return.