How high earners can escape the 50% rate of tax
High earners are leaving the UK at the rate of nearly 10 a week to escape the new 50% upper rate of tax on income over £150,000 that comes into force on 6 April. That's according to Rich List researcher Philip Beresford, who has analysed data from Companies House that reveals an exodus of limited liability companies and partnerships.
Nearly 500 directors and partners of UK companies have uprooted their families in the past year and moved offshore to addresses in Jersey, Guernsey or the Isle of Man, Beresford says.
While such drastic action may be worthwhile for the very highest earners, those with a headline salary of £90,000 or less could also be caught by the new tax measures once they have factored in taxable benefits such as cars or loans and income from sources such as rental profits, pension, bank interest, dividends and redundancy payments.
At the same time as the new super tax takes effect, the personal allowance - the first slice of income that is free from tax - will also be removed on a sliding scale.
The allowance, which is £6,475 this tax year and the next, will begin to reduce by £1 for every £2 of income above £100,000, disappearing entirely for those earning £112,950 and over.
This effectively means that for the £100,000 to £112,950 band of income there will be a marginal tax rate of 60%. This new dimension will be another factor in tax planning for people earning around £100,000.
Small wonder then that Danny Cox, head of advice at Hargreaves Lansdown, says that this year many more clients are taking early steps to protect their wealth and rearrange their assets.
1. Make the most of low tax on capital gains
The first thing to clock about the new regime is the disparity between the new top marginal rate of income tax and the rate for capital gains payable on the sale of assets, which is still set at 18%. These rates are seriously out of line. Such a large discrepancy is unlikely to go untouched for long, and many advisers recommend that investors sell some assets and crystallise their gains to take advantage of the current low rate of capital gains tax (CGT) before the government raises it, perhaps to 25% in the Budget.
The rules are that everyone can make £10,100 profit each year in the tax years 2009-2010 and 2010-2011 from selling an asset without paying CGT. You may, for instance, have share options that can be cashed in, where the share price has risen considerably since you last examined them.
Top earners should consider switching income-generating assets to capital-generating ones, such as property, art and antiques. Investments that are geared to capital include zero dividend preference shares with no income stream, and some guaranteed growth and structured products that are specifically designed to deliver capital gains.
Couples should consider switching investments between themselves to take advantage of both allowances. Even if CGT is raised, say to 25%, that is still significantly less than income tax.
2. Minimise your investment income
While top-rate taxpayers will be better off moving savings into capital-producing investments wherever they can, they may also think about accelerating certain income-producing investments to pay out before the end of the tax year to set them against this year's lower income tax rate.
For instance, if your bank or building society account pays interest annually as a lump sum, and it is due after April, you could consider closing the account now to receive the interest payment early at the lower tax rate. You could also exercise share options so you can pay any income tax due on them at a lower rate.
If you are in receipt of pension income, you may be able to receive your annual payout in a lump sum before April. Similarly, if you work for a small family business you may be able to ask your employer to pay some of your salary early.
You can also shelter income in a tax-efficient way within products from National Savings & Investments such as Index-linked Savings Certificates and Fixed Interest Savings Certificates.
Think about transferring income-producing investments to your spouse, or civil partner, if he or she is not working or pays a lower rate of tax. This now applies not only to spouses paying basic-rate tax, but also those on 40% if the other spouse earns more than £150,000.
The personal allowance is £6,475 in the 2009-2010 tax year, rising to £9,490 between the ages of 65 and 74 and £9,640 at 75 and over.
Also, if your partner is a non-taxpayer, make sure that you are not paying unnecessary tax on bank and savings accounts. Avoid the automatic 20% tax deduction on interest by completing form R85, which you can get from your bank, or reclaim it using form R40 from HM Revenue & Customs (HMRC).
Those with incomes just under £100,000 will particularly benefit from restructuring their savings to minimise income to ensure they are able to retain their full personal allowance.
3. Shelter investments in an ISA
No personal income tax or CGT is payable on any investment in an ISA and you are allowed to save up to £7,200 per person in the 2009-2010 tax year or up to £10,200 if you are aged 50 or over. If you invest in a stocks and shares ISA, any dividends you receive are paid net with a 10% tax credit. There is no further liability.
If you are not yet sufficiently convinced about economic recovery and do not want to invest in shares or funds in your ISA you'll need to shop around for an attractive cash rate.
Read our round-up of the best cash ISA rates
4. Don't forget investment bonds
The tax treatment of onshore investment bonds differs from other investments and can be attractive to high earners. There is no personal liability to basic-rate income tax or CGT on proceeds from your bonds, and you can withdraw up to 5% each year from the amount you have paid in without paying any immediate tax.
This allowance is cumulative so any unused part of this 5% limit can be carried forward to future years, but the total cannot be greater than 100% of the amount invested.
This is particularly useful if you are a higher-rate taxpayer and know that you will become a basic-rate taxpayer at some point in the future, for example on retirement. Then you might defer any withdrawal from the bond (in excess of the accumulated 5% allowances) until such time, thereby avoiding paying tax on any gains. However, an income tax liability will usually be triggered if you die prematurely.
Offshore investment bonds are similar to UK investment bonds, but no income or CGT is payable on the underlying investment so in theory it can grow faster than the one that is taxed.
As with an onshore bond, you can benefit from tax deferral - tax will not arise until the bond is encashed or more than the 5% tax-deferred allowance is taken out, and you can either wait until you become a non-taxpayer before doing this or you can move abroad and become a non-UK resident before doing so.
5. Maximise your pension contributions
From 2011, tax relief on pension contributions for those with an income of £180,000 will fall to the basic rate and employer pension contributions will count as part of an individual's gross income, although only if your income, excluding the employer's contribution, exceeds £130,000. These changes could affect between 100,000 and 200,000 additional people.
Those with incomes of more than £130,000 should consider paying as much as they can towards pensions while higher-rate relief is available. But to prevent an artificial short-term rise in pensions saving, the government has brought in new rules limiting the pension payments that can attract higher-rate tax relief for this tax year and next.
However, everyone can contribute at least £20,000 to their pension with 50% tax relief, and some can put in up to £30,000 if HMRC agrees that this is a normal amount for that person before the tax relief is restricted in 2011.
The government has now had two bites at the pension tax relief cherry and currently only those with incomes of more than £130,000 will be hit, but there is a widespread expectation that a third attack will be made as the government is forced to cast its net wider for additional savings. So increasing pension contributions is a sensible step while you can still benefit from higher-rate relief.
6. Switch to salary sacrifice for big tax savings
One way of reducing your tax is salary sacrifice, where your employer allows you to give up some of your salary in exchange for enhancement to benefits such as pension contributions, medical insurance or gym membership, thus saving the tax on that portion of sacrificed income.
The removal of the personal allowance for those with an income above £100,000 and the 1% increase in national insurance (NI) from April 2011 make salary sacrifice highly attractive.
The primary NI rate, which applies to earnings of between £5,720 and £43,875, will rise from 11% to 12%, while the upper rate of 1 per cent for all earnings in excess of £43,875 climbs to 2%. NI paid by employers will rise from 12.8% to 13.8%.
High earners hit by the withdrawal of the personal allowance can enjoy tax relief of up to 65.4% by exploiting salary sacrifice rules when planning pension saving.
The folowing example shows the saving where someone earns £112,950 and would otherwise have lost their entire personal allowance. But those with higher incomes can also benefit to the tune of 55% to 65%.
The optimal case involves someone on an income of £112,950, who enters into salary sacrifice to cut their salary to £100,000 to regain the personal allowance, and puts the difference of £12,950 towards their pension.
Standard Life has calculated that this will reduce the tax they have to pay from £37,700 to £29,950, a saving of £7,750, and reduce take-home pay by £5,051. But it will translate into a pension contribution of £14,607 and create a NI saving for the employer of £1,657.
7. Venture capital trusts & enterprise investment schemes
VCTs and EISs offer tax breaks to encourage investment in small businesses. VCTs offer more attractive income tax relief that is equal to 30% of the sum invested in newly issued VCT shares, while EISs attract 20% income tax relief, but are more useful for inheritance planning as they are exempt from inheritance tax after two years. Tax breaks are available for investments up to £200,000 for VCTs and £500,000 for EISs in each tax year.
Poor annuity rates and onerous rules on taking pension benefits have encouraged some advisers to tout VCTs as an alternative to pensions for high earners. But they have a significantly high incidence of failure and this approach could be a case of the tax tail wagging the investment dog.
To get the upfront tax relief you have to subscribe to a new VCT issue. But there are advantages to buying second-hand shares, as all VCT dividends and capital gains are tax-free. VCTs that have performed well include Baronsmead VCT & VCT 2, British Smaller Companies VCT, Foresight 4 VCT and Northern Venture Trust Albion VCT.
Investec is launching its first VCT in conjunction with Calculus Capital. It will invest in structured products and venture capital investments to diversify risk. It aims to generate an annual dividend of 5.25p per share for five years, plus 43.75p per share after five and a half years, by way of a special dividend or a cash tender offer.
Finally, there's Oxford Capital's new Approved EIS Fund targeted at companies in the fashionable healthcare, sustainability and communications sectors.
This article was originally published in Money Observer - Moneywise's sister publication - in March 2010
A tax-efficient way of receiving staff benefits, where an employee agrees to forego a proportion of their salary for an equivalent contribution into their pension scheme or in exchange for company car, gym membership, childcare vouchers or private medical insurance. A salary sacrifice scheme is a matter of employment law, not tax law, and is often entered by an employee who is about to move into the higher 40% tax bracket.
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
Venture Capital Trusts were introduced in 1995 to encourage private investments in the small-company sector by offering tax relief in return for a minimum investment commitment of five years. A VCT is a company, run by a fund manager, which invests in other companies with assets of no more than £7m that are unlisted (not quoted on a recognised stock exchange) but may be listed on the Alternative Investment Market (AIM) or plus with the aim of growing the companies and selling them or launching them on the stock market. Investors in new VCTs are offered desirable tax advantages and VCTs themselves are listed on the London Stock Exchange, with strict limits laid down by HM Revenue and Customs on what they can invest in and how much they can invest.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.