Simple ways to stay tax smart

Welcome to Word on the Street's Personal Finance podcast from Barclays UK where our experts share their knowledge and insights to help you become a better and more confident investor. In this episode of our Word on the Street Personal Finance series we discuss what savers and investors might consider about tax efficiency and the types of accounts they could use to shelter their hard earned returns.

Phil Attreed: Hello and thank you for joining especially those listeners who regularly join our established weekly market and investment debates. This is the second episode of our extended Word on Street series focused on all things Personal Finance. In this session we'll move on from getting ready to invest and establishing financial goals to focus on what our listeners might consider about tax efficiency and the types of accounts they could use to shelter their hard-earned returns from tax. Of course it's always important to make sure that investments make sense in their own right and a phrase we often return to with clients is not allowing the tax tail to wag the dog, investments after all can fall in value as well as rise. I'm Phil Attreed, Barclays Head of Investment Consulting and for this episode I'm joined by Lee Platt one of our director wealth planners whose expertise in these topics should help us navigate these important considerations. We would highlight upfront that all tax rules can and regularly do change, their effects always depend on your individual circumstances which can also change and whilst Barclays don't offer personal tax advice independent advice should be obtained if you have concerns about the next steps on the journey. Now Lee let's start by just thinking about why our tax allowances are so important when it comes to saving and investing. Having worked with thousands of investors over the years I know it's not just those who who've worked the hardest at hunting down the best savings bond or picking the best investment that have necessarily made the most money. Those who've equally focused on the tax they'll pay on their hard-earned returns have often actually achieved more of their financial goals.

Lee Platt: Yeah that's right Phil, so tax is an important variable it's a real drag on performance so you know it does make sense to plan to minimize the impact of tax where suitable, which can provide compounded returns over time. So for example let's assume that you've got £10,000 that you want to save and invest and let's assume that you're at a basic rate taxpayer. Now this can change but basic rate is currently at 20%. Now, if you assume a four percent return over a period of say ten years then the net of tax return would work out at 3.2 percent and of course that's assuming that the basic rate of tax doesn't change over that period. Now over the ten-year period the difference between the gross return of 4% and the net return of 3.2 of course is 0.8% and that drag on the £10,000 invested would equate to a loss of £1,100 pounds. So you know the importance of compound growth is you know really important but compounded tax is a real drag.

PA: And Lee as a UK taxpayer I have quite a range of taxes, and therefore allowances and planning opportunities and we're not going to be able to cover everything in this session but let's start with the key taxes, the thresholds and the associated allowances.

LP: Well Phil, tax can be complex and so to position this I've taken some information directly from the HMRC website. Now there are many tax allowances, reliefs and variables all depending on each individuals circumstances, so for this let's focus on some of the main ones for investors to consider. So let's have a look at the personal allowance, so this allows the first £12,500 worth of taxable income to be received with no tax rate taken. Now all UK tax registered individuals, including children from birth can benefit from this allowance. Now it's important to note however that people with taxable income in excess of £100,000 could start to lose their personal allowance as this is reduced for £1 for every £2 of income above £100,000. So that means that you wouldn't be entitled to a personal allowance if you'd got taxable income that was over £125,000. The second one would be a starting rate for savings. Now many people aren't aware of this allowance and it is in addition to the personal allowance as we've just mentioned and you may also get up to £5,000 of interest from savings and not have to pay any tax on it. And this works on a tapering scale for income more than the personal allowance so for example if you earn money from wages and you've got income from a pension as example then the starting rate for savings will decrease, and if your income is £17,500 or more then you would not be eligible for the starting rate for savings. That moves us on to the personal savings allowance and this is an allowance that applies to interest from banks, building societies and many but not all types of taxable investments. You may get up to £1,000 of interest and not have to pay tax on it and for higher rate taxpayers this allowance reduces down to £500. It is important to note that this allowance is not available to any individual falling into the additional rate tax band. The penultimate one is the dividend allowance this allows individuals to get £2,000 worth of dividends each year and you would only ever pay tax on any dividend income that is above the dividend allowance of £2,000. So the final one there is Capital Gains Tax allowance, you only have to pay Capital Gains Tax on your overall gains which are above the tax-free allowance. That allowance is £12,300 and in my experience with clients this is a really valuable allowance that many investors do not maximize each year.

PA: Fantastic, really useful Lee, of course it's important that our listeners understand that all of the information we're referencing can be subject to changes particularly as economic and political drivers they influence taxation and so it's good practice to refresh yourself on those main elements every so often, and I generally encourage family and friends to use the annual budget as a good trigger point for a bit of a review of those allowances. So when it comes to savings and investments I definitely think about how different solutions are going to be taxed for me and in my case also in the case of my partner, especially with our very different tax rates and allowances in mind. This has a strong bearing on the return we will ultimately be left with.

LP: Yes Phil, so with low returns on cash savings there are many investors who may not actually fall into the territory of paying tax on savings unless they are high earners. Again this can change if the government needs to increase taxation and if you are uncertain of your position then I would certainly encourage you to seek advice from a tax professional.

PA: Absolutely Lee, and again we're not going to be able to cover off all complexities here but turning to a typical investment portfolio or a diversified managed fund, I'm hopefully going to be making some investment gains from owning some shares in there, these gains are going to be subject to the Capital Gains Tax where they exceed that annual allowance. I might also in that portfolio expect to receive some dividends from the companies that I've invested in, again I helpfully have a separate allowance that you reference there Lee for dividends but if I'm investing a reasonable amount of money and possibly in companies that pay slightly higher dividends then I might want to think about the tax I could be paying there. A good illustrative reference point for our listeners for investors is the historic average dividend yield so the rate paid by UK companies which is kind of around about 4%, so as a rule of thumb anything more than about £50,000 invested might start to attract some dividend tax. Finally looking at that portfolio or managed fund I might have some bond investments in the portfolio so these are going to be loans to governments, or to companies, and the interest payment that I receive on that loan to those governments or companies that may be subject to income tax. So I should think about my other sources of income tax and what income tax rate that I might already be paying, say from salary or pensions as this will affect the overall rate of tax that I'm going to be be paying.

LP: Absolutely Phil, so you know while some investors might never exceed their annual allowances it is important to remember that these allowances cannot be carried over from one financial year to another. So it works on the basis of if you don't use them then you lose them and this is especially important for Capital Gains Tax where an investor might have sold shares or hold a fund for many years and in doing so could build up hopefully quite sizeable gains. This is why it's so important that investors review their tax planning on an annual basis.

PA: Great that leads us nicely onto our next topic of the basic tax efficient accounts to shelter our savings and investments in. On top of the allowances we've discussed there's some good news here. Should we start with ISAs Lee?

LP: Yes, so Individual Savings Accounts, you can use them to save cash or invest in stocks and shares and you can pay your whole other annual allowance which is £20,000 at the moment into a stocks and shares ISA or into a cash ISA or any combination of these. Importantly, given what we've already discussed and you pay no income tax on the interest or the dividends that you receive from an ISA and any profits from an ISA investment are free of Capital Gains Tax. Now it's important also to note that if you do have to complete a tax return then you don't need to declare any ISA interest income or capital gains on it.

PA: Thanks Lee, there are also four more specialist ISAs so we've got Help to Buy, Innovative Finance, Lifetime ISAs and child ISAs. So whilst the latter two they absolutely enable for very similar tax efficient investments to the ones we're referencing, maybe we'll record a separate session specifically on the detail of all of these for another podcast. Whilst many investors understand the tax benefits let's maybe dispel some of the common myths about ISAs. So the first one for me is that many clients of mine over the years, they actually correctly understood that any money you'd withdrawn from your ISA or PEPs back in the day could not be replaced but that's changed I think now Lee, is that right?

LP: Yes, well interestingly Phil you know some ISA providers now offer a flexible facility that will allow you to withdraw and replace money from your ISA provided it's done within the same tax year. Now not all ISAs will allow you to do this and you should check with your ISA provider and that your individual ISA has this function.

PA: So second myth possibly the most common and one that frustrates me the most is the view that once you've selected your ISA provider you're stuck with it for the duration of your investment, or risk losing these tax advantages.

LP: Yes you know many investors are unaware that savings and investments in ISAs can be transferred to a new company or ISA provider without losing the tax advantages. Now you know this means that if there's a better savings rate available or you're not happy with the investments in your ISA or you know there's a cheaper alternative provider, then it should be reasonably simple to transfer or consolidate prior years ISAs to a new ISA provider. Now it is important before transferring you should consider this carefully and be aware of any adverse consequences you know and that could for example be breaking any conditions or any tie-ins on your existing investments and you know I would encourage everybody to seek advice if they are uncertain.

PA: Yes of course Lee and you know there is always a period in which you're likely to be out of the market as well and who knows you know markets could perform well during that period you know while you're moving the money's across from provided to provider. But that leads me on last but certainly not least to the last of the myths that ISAs need to be cashed out before they're inherited.

LP: Well actually Phil you know any surviving spouse or civil partner and can now inherit a deceased ISA and their ISA allowance in addition to their own.

PA: Good news, so the second area we thought we touch on is pensions so the government encourages you to save for your retirement by giving you tax relief on pension contributions. Lee do you want to touch on the various ways in which our listeners might find themselves contributing or holding a pension.

LP: Sure so employed individuals could be making contributions and/or receiving them from an employer and the self-employed could also be making their own pension contributions. It's also important to note that all employers must provide a workplace pension scheme. Now you may have come across this before and it's called automatic enrolment it means that your employer must automatically enrol you into a pension scheme and make contributions to your pension if all of the following apply. So these are you are classed as a worker, you are aged between 22 and the state pension age, you earn at least £10,000 a year and you usually or ordinarily work in the UK. Now if you're unsure of your position around auto enrolments then you should check with your employer to know exactly where you stand. There are various types of pensions and they all work in different ways depending on if they are personal arrangements or if they are employer-sponsored pension schemes, but they are one of the most tax efficient vehicles although still widely underutilised. The benefit of tax relief on the pension contributions makes these a really valuable way of saving for the future and recent changes to pension legislation have also made pensions more flexible than ever. However, pensions can be technical, they can be complex and they are subject to restrictions so again you know I would encourage people to speak with a financial adviser or a body like the Money Advice service if you're unsure or you just want more guidance around pensions.

PA: And Lee, so what are the key features of a pension that our listeners should really look to get to know if you like to get them started?

LP: So there are three things to consider when looking at pensions and these are tax relief on their contributions, how much you can contribute to a pension and also you know how can you access your pension.

PA: So let's first look at the tax relief. Getting tax relief from contributions is clearly a key benefit.

LP: Absolutely, now the way in which you get the benefits of tax relief will depend on the type of pension scheme that you have. So for example a defined benefit also known as final salary pensions and employer led pensions like the workplace pension through auto enrolment that we've just mentioned can see contributions being made from your salary before tax is deducted. What that means Phil is that you know you then have a gross payment that's made into a pension on which you have not paid any tax. Now for personal pension arrangements so this is where an individual is making their own personal pension contribution, then tax relief is applied at the basic rate which is currently 20% and that's added to or what's referred to as grossed up inside of the pension. So the contribution is increased by the basic rate of 20%. Now for basic rate taxpayers there'd be no further action however what is important is that for higher or additional rate taxpayers, that they can then claim the additional tax relief of 20% for a higher rate taxpayer or 25% for an additional rate taxpayer through completing their self-assessment. And you know in my 20 years of advising clients I've seen this missed by so many people but it's a really vital to ensure that you're maximizing your available tax relief on your pension contributions and it's also worth noting that where tax relief increases the amount paid in you can also get tax relief at the basic rate even if you're a non-tax payer so again you know really valuable tax relief on pension contributions.

PA: Yes, as you say Lee, a vital area that people sort of consider but equally get right. Let's move on to how much though you can contribute to a pension. What do people need to know about this?

LP: So that the maximum annual contribution as a general rule of thumb is the lower of £40,000 gross or 100% of pensionable income whichever is the lowest, and this is called the annual allowance. Now it is important to note however that this annual allowance can be impacted for high earners and especially those with income exceeding £200,000 and they should definitely seek financial advice to understand their position. On top of this Phil if your pension fund grows and it grows free of tax with provides the benefit of compounding as we mentioned earlier and there is of course no guarantee that your pension investments will grow in value like all investments you know you could see a fall in value as well as rises.

PA: So the third thing people need to consider is I suppose accessing the pension ultimately, what options do people have there?

LP: So Phil you can usually take up to 25% of your pension funds as a tax-free lump sum under the current rules. Your regular pension income is taxed along with the rest of your other income. Now all of this comes with the understanding that the pension can't be accessed until minimum retirement age, and now that is currently age 55 but it is expected to rise in the future. And this can vary for different types of pensions so again it's important to check with your pension provider to know exactly where you stand on what the rules of your individual pension scheme is. There are some individuals who also may have certain types of protections in place for their pensions and that's due to previous changes in pension legislation over the year and again those protections are subject to certain rules. If you do have any protections in place or you want to check if you're unsure then again I would encourage you to seek financial advice or speak with the Money Advice service.

PA: Fantastic, so I mean a bit like the ISA pensions are a great way for long-term investors to plan for financial goals around retirement, this enables the pot of money to maximize growth of the investments without being taxed along the way the difference obviously with pensions being that there's an incentive at the point of putting the money in, but potential to pay some tax when you look to spend that money at the end when you're retired. As we mentioned earlier you know the earlier we start saving and investing particularly in these sort of tax shelters the better the potential returns for our money to grow. I'd love to hear just a few tips from you Lee just around pensions though, have you got any other top tips for us?

LP: Yes, so you know tracking down a personal or workplace pension is usually a popular request or question that that we hear so it's most pension schemes of which you've been a member must send you a statement each year. If you're no longer receiving these statements and that perhaps could be because of a change of address, then to track down the pension there are three main bodies that you can contact. The first of these is of course the pension provider, you can also refer to the pension tracing service and that's available online or if it's an employer based scheme then you know you could also contact your former employer to get some information or to make sure that you are receiving up-to-date information on a workplace pension. The next one would be a state pension statement or a state pension forecast and this will really give you an estimate of how much state pension you might get based upon your National Insurance contributions to date and it will also help you to understand how any future National Insurance contributions might increase the amounts shown and that's particularly important for those that are in say the forties or the fifties and you know you might want to view that to see what the options are whilst you're still in a position to do something about it to fill any potential gaps or shortfalls in receiving your full state pension. And probably the last one is around third-party contributions. So this might be for people that are looking to contribute into pensions for their children or it might be that they want to make pension contributions on behalf of somebody that is a non-tax payer as an example, as you said Phil, the earlier your pension savings start, the benefits of compounding you know can make a substantial difference to the to the total pension value on reaching retirement age. You know and for example for myself I've got a daughter she's aged 15 and I started to contribute an amount of £2,880 each year into a children's stakeholder pension from her first birthday. And I'll continue to do that until she reaches aged 18 and that's when she can start making pension contributions on her own. Now every time that I make a payment into the pension, as we again we mentioned earlier you know this payment is grossed up by the basic rate of tax relief, again currently twenty percent and that's increased inside of the pension from £2,880 up to £3,600 which is a fantastic benefit. Add that with the other benefit of the compounding growth, the tax-free growth inside of the pension and over a period of in my case you know eighteen years and that's going to give my daughter an amazing start on which to build her own pension pot to support her in later life.

PA: Thanks for those tips Lee, that's one very lucky daughter, I'm certainly going to have a look at going back to sort of see my state pension statement. I think I probably know where I am with my employers having been here at Barclays for quite some time. But yes I mean I think the point around making those sort of third-party contributions as well it's one I always sort of keep putting off but again the earlier we do it the better the potential I think as you say for setting up the youngsters for life. So in our final section let's just touch on the basics of a little bit more complex but Enterprise Investment Schemes, EIS, and Venture Capital Trusts so VCT's. These could actually have their own podcast to be honest and we may well look to cover that in isolation as part of the overall series but just some very sort of brief thoughts on that Lee.

LP: Yes, so these are government backed investments into smaller companies to compensate for the potential higher risks involved then you know the government does offer some generous tax reliefs, such as 30% income tax relief and not having to pay tax on any gains. Now you know these are not for everyone but where used alongside other investments you know such as pensions or such as ISAs then you know they can offer the potential for higher tax efficient returns.

PA: Fantastic, as I say we may well look to revisit those in the interest of time. So if this has wet the appetite of our listeners are there any other good sources of information to sort of further their understanding Lee?

LP: Yes, so you know anything outside of basic allowances or ISA subscriptions you know probably requires more input from an advisor. You could also contact other bodies like the Citizens Advice Bureau, at the Money Advice service or HMRC website is really good for factual information. You could also view the Barclays Smart Investor website and it's a great resource and there's some great articles and information on that, and of course you know if you are a Barclays wealth client you know then please do speak with your wealth manager, it is important though Phil as ever to confirm that Barclays does not offer tax advice and you should seek tax advice from a tax professional.

PA: Absolutely, thank you so much Lee for joining me for this episode we'll definitely have you back on as we step through the various stages of the savings investments journey with this podcast series. Thank you also to our listeners, hopefully there's some thought-provoking insights in there for you today. As always you can listen to our regular Friday podcasts on the latest markets and investment thinking. And we'll be back soon with the next episode in this Personal Finance series.

Tax treatment descriptions mainly involve investments and investments can fall in value as well as rise and their past performance is not a reliable indicator of a future performance. All tax rules can change in future and their effects depend on your individual circumstances which can also change. We don't offer personal tax advice. You should obtain this independently if you are unsure. This podcast is not a personal investment recommendation.