How to manage your wealth efficiently as “stealth taxes” bite

Back in April 2021, you might have seen our guide to the year in tax that provided you with all the important information you needed following the Spring Budget. But important financial announcements didn’t end there.

The Budget’s “stealth taxes” were followed by the introduction of a new Health and Social Care Levy and the suspension of the State Pension triple lock.

These tax increases in the wake of the coronavirus pandemic have coincided with inflation exceeding 5%, leading to a potential cost of living crisis for the year ahead.

Planning for a comfortable retirement while leaving enough to provide an inheritance for the loved ones you leave behind is always a tricky balancing act. Here are three important points to consider in light of recent threshold freezes and tax increases.

1. Your Personal Allowance is frozen until at least 2026

The Personal Allowance is currently £12,570 and it will remain at this level until 2026. The threshold for higher-rate taxpayers is £50,270 and is likewise frozen.

As inflation reached 5.1% in November 2021 – the highest rate in a decade – recent figures from the Office for National Statistics (ONS) confirm this is above wage growth. Total earnings grew at an annual rate of 3.5% in November, meaning real-terms pay cuts for many in the short term.

Over the next five years, you could also see your take-home pay eaten into by the frozen allowance, which is expected to raise around £6 billion for the Treasury before 2026. This could affect the amount you can contribute to the pension, with a knock-on for your retirement date, the amount you can save for later-life care, and the amount you can pass onto the next generation.

2. The Lifetime Allowance (LTA) is frozen too

The LTA limits the amount you can withdraw from your pensions without becoming liable to a tax charge. The LTA charge currently stands at 55% for any pension funds exceeding the limit that you opt to take as tax-free cash. You’ll pay 25% on any excess you take as income.

As with the Personal Allowance, the LTA has been frozen until 2026. The allowance of £1,073,100 is expected to raise nearly £1 billion for the Treasury.

If you are nearing retirement and fear you might trigger the LTA, you must get advice. While accepting the LTA charge might be the best option in some circumstances, we can help you find the most tax-efficient way to save for your future, ensuring your estate can be passed on to those you love with as small a tax liability as possible.

3. Inheritance Tax (IHT) and the frozen nil-rate band

Another “stealth tax” that was announced last year was the freezing of the IHT nil-rate and residence nil-rate bands.

Frozen until 2026, the nil-rate band will remain at £325,000 while the residence nil-rate band will stay at £175,000.

If your estate on death exceeds £325,000, the excess will be liable for IHT at 40%. The residence nil-rate band allows you to pass your home onto direct descendants – children or grandchildren, for example – to the value of £175,000. This effectively increases your tax-free threshold to £500,000.

With both rates frozen, rising house prices and increasing values of pensions and investments will continue to increase estate values pushing more people into an IHT liability. This extra liability could amount to an extra £985 million for the Treasury.

One way to lower the value of your estate for IHT calculation purposes is through making use of certain HMRC gifting exemptions.

The annual exemption

You can gift £3,000 in a tax year using your annual exemption. It is also possible to carry an unused exemption forward for one year, so check if you can afford to make larger gifts and whether you have any unused exemption from last year.

Normal expenditure out of income

If you intend to leave money to your children on death, consider giving while living and making use of the normal expenditure out of income exemption. You can make IHT-free gifts as long as they are regular, made out of income, and don’t detrimentally affect your standard of living.

Get in touch

If you would like to discuss any element of your financial plans in the approach to tax year end, please email or call 01793 575553.

Please note

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. You could lose your investment. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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