Tax Efficiency Advice – Plan Ahead!

By: C Wathen Click author's name for more of his/her articles

The UK government’s Pre-Budget Report announced a variety of proposed changes to income tax and national insurance contributions (NICs) over the next three tax years. Any tax efficiency advice should take into account these changes as part of your strategic financial planning.

2009/10

The main personal allowance will rise by 7.3% – more than inflation – to £6,475. The basic rate limit will also increase by more than inflation, from £34,800 to £37,400. The Chancellor’s apparent generosity is countered by a substantial increase in the upper level at which full rate NICs are paid – from £40,040 to £43,875.

If you are a contracted in employee with earnings above the new upper NIC threshold, the result of these changes in the next tax year is an increase in net annual income of about £343.

2010/11

Personal allowances will be restricted for high earners in a complex two-stage approach:

1 If your gross income is between £100,000 and £140,000, your personal allowance will be reduced by £1 for each £2 of income over £100,000, subject to a maximum total reduction of half the personal allowance. So assuming a personal allowance of £6,600, your personal allowance will be halved (to about £3,300) if your income is above about £106,600.

2 If your gross income exceeds £140,000, your remaining personal allowance will be reduced again by £1 for each £2 of income over £140,000. As a result, you will have no personal allowance if your income is more than about £146,600.

These phased reductions create two bands of income around £6,600 wide, where the effective marginal tax rate is 60%, ie for each £2 of extra income you pay 40% tax on £3.

2011/12

There are two important changes due in this tax year:

1) NIC rates for employees, employers and the self-employed will rise by 0.5%. For example, if you are a company director contracted in to the state second pension scheme, your personal NIC rates will become 11.5% and 1.5% (against 11% and 1% now) and your company’s contribution rate in respect of your earnings will rise from 12.8% to 13.3%.

2) There will be a new 45% income tax rate (37.5% for dividends) for taxable income above £150,000.

The 2011/12 tax and NIC increases (and possibly the 2010/11 personal allowance cuts) will not take effect until after the next general election. So far the Conservatives have not said that they will abandon any of the proposed measures: a projected £118bn budget deficit in 2009/10 means that the extra government revenue will need to come from somewhere.1 In any case, in tough economic times, a pledge effectively to cut tax rates for high earners would be politically difficult.

For now, it makes sense to assume the proposals will become law and start planning accordingly:

-If you are married or in a civil partnership, make sure that you and your partner are taking maximum advantage of independent taxation.

-If you could be caught by the restrictions to personal allowances, see whether it will be possible to avoid the 60% marginal rate band, for example by transferring investment income to your partner.

-If paying 45% income tax from 2011/12 is a possibility, think about bringing forward income into an earlier tax year.

-Capital gains tax remains at 18% and gains are not treated as income for personal allowance calculations. All other things being equal, investment returns in the form of capital gains are preferable to dividend or interest income.

If you want to examine future tax planning further, a good starting point would be to raise the issue as part of your tax year end planning review. The Financial Services Authority does not regulate tax advice.

Gemini Wealth Management are Independent Financial Advisers (IFA) that provide tax guidance, independent financial advice and other financial planning services for personal and business use in the UK.

Gemini Wealth Management Ltd is Authorised and regulated by the Financial Services Authority Registered in England & Wales No. 5919877 Registered Office: Gemini House, 71 Park Road, Sutton Coldfield, West Midlands B73 6BT The Financial Services Authority does not regulate tax and trust advice, will writing and some forms of buy to let mortgages. The guidance and/or advice contained in this website is subject to regulatory regime and is therefore restricted to consumers based in the UK.