The spring budget brought changes to the tax system that will affect different people in different ways
With the UK and Scottish governments paying out huge sums of money both through the pandemic and on into the present, some serious revenue-raising changes are being made to the UK tax system in the year ahead. Most of these have already been announced, though the Chancellor had a major surprise in his spring budget on March 15.
The new tax year began on April 6, which represented the cut-off date for those wanting to mitigate their tax exposure. People now need to focus on what they can do through the 2023 to April 2024 tax year to mitigate their tax and maximise their long-term savings potential.
The significant change that Jeremy Hunt made wasn’t the decision to freeze the tax allowance bands for the next six years. That had been widely trailed prior to the budget and is bad news for low and medium earners. This is because it guarantees that they will pay more tax as their employer struggles to keep salaries in line with inflation. You can’t do anything about that.
The big change – which again will mean nothing to low and medium earners – is that the Chancellor has scrapped the lifetime limit on how much anyone can save in their pension. He has kept the £40,000 annual limit on the total amount that you can pay tax free into your pension fund, but the lifetime limit of £1,073,100 – frozen at that level since 2020 – has gone.
Some tax experts argue that this is only sensible, because it does not make a lot of sense to impose both an annual limit and a lifetime limit on pension contributions. However, under the old system that pertained until this latest budget, anyone lucky enough to have a pension pot grow by £40,000 a year would have used up their entire lifetime allowance in a little under 27 years.
Now they can keep on accumulating at that rate for their entire working or earning life, which could be much more than 27 years. Great news of course if you are one of the top 1 per cent of earners, or if you have ambitions to be at that level soon – but entirely forgettable for the rest of us. Not surprising then that the Conservatives are getting some stick for looking after their uber-wealthy supporters.
The budget means that more people will be falling into the highest rate tax band in the current tax year. The income tax bands for the 2023/2024 tax year remain at 20 per cent for earnings between £12,571 and £50,270. The higher rate tax band of 40 per cent kicks in at earnings between £50,271 and £125,139 and the additional rate, as it is called, of 45 per cent hits all those earning over £125,140.
This means many more people will end up in the 45 per cent tax band. At the same time, the tax-free personal allowance of £12,570 from the 2022 to 2023 tax year has been frozen at the same level. This is not great news since the personal allowance has often in the past been increased by whatever the UK Government deemed the current inflation rate to be.
Since we are now at a 40-year high in terms of inflation, which is currently running in excess of 10 per cent, freezing the personal allowance results in a de facto cut in its value of at least 10 per cent. If you are lucky enough to have been given a significant pay rise to match or partially counter the way inflation has eaten into your salary, it means you will be paying more tax unless you take some mitigating action.
So what to do? There are basically two ways to take advantage of the reliefs provided by the UK tax system. One is to invest in products such as ISAs, where the growth of your investment is tax-free. There is a £20,000 cap on the amount you can invest in an ISA annually and it is on a ‘use it or lose it’ basis. You cannot roll any unused ISA allowance forward.
Paul McFadyen and Nadeen Watson of Spectrum Wealth Group point out that the Lifetime ISA (LISA) is particularly interesting for those under 40 (that’s the age cut off for LISAs, so starting in your 20s or 30s makes sense).
You can contribute up to £4,000 of your £20,000 annual ISA allowance to a LISA. What makes a LISA special is that the government will contribute a further 25 per cent to anything you pay in each year, up to a maximum of £1,000 in any tax year. (There are other conditions, details of which can be found online.)
Or, McFadyen and Watson note, you can opt to invest more into your pension from your salary. The government will pay the tax on the amount you invest directly into your pension fund for you. This means that for a basic rate taxpayer paying £100 into their pension, the government will add £25.
Your pension provider automatically claims the basic rate contribution on your behalf and adds it to your pension pot. Higher rate or additional rate taxpayers claim the additional tax relief through their tax returns. In Scotland we pay a slightly higher rate than in England so the pension is even more beneficial to anyone resident here.
The good news is that you can opt to increase your pension contribution for the current year up to a maximum of 100 per cent of your salary, or £40,000, whichever is the lower. Of course, these limits are way out of reach for most people, but it is still worth thinking about doing what you can.
Watson makes the point that it is extremely difficult for anyone in their 30s or 40s to work out on their own how much they are likely to need to be comfortable when they retire. The best course of action, she argues, is to talk to a financial planner who will help you work everything out.
As PwC tax partner Susannah Simpson notes, pensions are such a powerful tax win that it is almost always a ‘go-to’ recommendation for financial advisors to make to their clients.
Apart from pensions and ISAs, if you are wealthy enough to have disposable assets, be it property or shares, Simpson points out that you need to be aware of the coming changes to the capital gains tax (CGT) allowances. This is a real stinger.
For some time now people have been able to make up to £12,300 tax-free gains every year on assets that attract CGT. The present tax year, 2022-23, is the last time the allowance will be this generous. In the next tax year the allowance drops to £6,000, and the year after it halves again to £3,000. So if you had something that you’ve made a profit on, and failed to sell it before April 6, 2023, tough luck. You now have just half the CGT allowance that you would have been able to claim had you sold whatever it was, before April 5. It halves again next year. You’ve been warned.