On 8 July 2015, the Chancellor of the Exchequer presented his Budget to Parliament. Below you can see a summary of what this may mean for you, from a savings and retirement perspective.
- State pensions will continue to increase in line with the ‘triple lock’
- A new inheritance tax main residence nil-rate band is to be introduced
- Taxation of dividends received from shareholdings and mutual funds (e.g. OEICs, unit trusts and investment trusts) is to be simplified
- Annual contributions to pensions potentially restricted for anyone earning over £110,000
- Pensions lifetime allowance reduction to £1m confirmed for April 2016
- ISA flexibility announced for cash ISAs in March 2015 Budget to be extended to cash held in stocks and shares ISAs from April 2016
- Buy-to-let mortgage interest tax-relief to be restricted to the basic rate of income tax
It has been confirmed that the state pension triple lock will be maintained for the duration of this Parliament (until 2020). To recap, the triple lock was introduced in 2010 and guarantees to increase the state pension every year by the higher of the rate of price inflation, the rate of wages growth or 2.5%.
On average, state pensions make up between one-third and one-half of pensioners’ total income, so ensuring that state pensions continue to increase at a healthy rate will help pensioners cope with increases in the cost of living.
Currently, everyone is entitled to a £325,000 inheritance tax ‘nil-rate band’ meaning that if total assets passed onto the next generation are less than this amount, no inheritance tax will be paid. In addition, married couples and civil partners are allowed to pass on any unused nil-rate band of the first partner to die, meaning that the survivor can have a nil-rate band of £650,000 if the first to die does not pass on any taxable assets when they die.
New rules will introduce an additional main residence nil-rate band which can be used in addition to the normal nil-rate band where a residence is passed on to a direct descendant. This will be £100,000 in tax year 2017-18 rising to £175,000 by tax year 2020-21.
The allowance will be given to each individual and, like the normal nil-rate band, can be transferred to a surviving spouse or civil partner if not used on death. This means that a married couple or civil partners could enjoy a combined nil-rate band of £1m (assuming all allowances passed to the survivor) by tax year 2020-21.
Many people have experienced a rise in the value of their residential property, particularly in property hot-spots such as the South-East of England, London and Edinburgh. This new allowance will ensure that fewer estates will be caught by inheritance tax, which is a tax traditionally aimed at the wealthiest estates.
Current rules until 5th April 2016
Currently, people who have shares are liable for tax on the dividend income received, but also benefit from a 10% tax credit.
To calculate the amount of tax due, dividends received must first be ‘grossed-up’ to calculate the gross dividend. This is done by dividing the amount received by 90 and multiplying by 100.
For example, a dividend of £90 would have a gross taxable value of £100.
The tax on dividends paid by basic rate taxpayers is 10% meaning that tax of £10 would be due in the above example, but the 10% tax credit received with the dividend (£10 in our example) reduces the tax due to zero.
Higher rate taxpayers (people with taxable income between £42,385 and £150,000) pay tax on the gross dividend at 32.5% and also receive a 10% tax credit, so their tax due on a £100 gross dividend would be £32.50 minus £10 tax credit, leaving £22.50 to be paid in tax.
New rules from 6th April 2016
The dividend tax credit will be abolished and instead, everyone will receive an annual Dividend tax Allowance of £5,000 a year.
From 6th April 2016, if dividend income received is less than £5,000 in a tax-year, then no tax will be due. On any excess over £5,000, tax will be paid on the excess at the following rates:
• 7.5% for basic rate taxpayers;
• 32.5% for higher rate taxpayers; and,
• 38.1% for additional rate taxpayers.
This change will simplify the taxation of dividends for the majority of people holding shares or receiving income from mutual funds such as unit-trusts, OEICs and investment trusts. If total dividend income received is less than £5,000, no tax will be payable. This should also lead to more straightforward self-assessment returns for the majority of people who own such investments.
PENSIONS ANNUAL ALLOWANCE
From April 2016, people whose net income is more than £110,000 could potentially see the annual amount they can put into pensions reduced from the current limit of £40,000 a year.
Those with income, excluding pension contributions, of less than £110,000 are not affected and will retain their annual allowance of £40,000.
Those with income, excluding pension contributions, above £110,000 will have to add on the total of their own and their employer’s pension contributions. If this takes total ‘adjusted income’ above £150,000, then their annual allowance will be restricted by £1 for every £2 which their income exceeds this threshold.
Example 1 – Gillian
Gillian has annual income, excluding pension contributions, of £107,000. Between Gillian and her employer, £30,000 gross is paid into her pension each year.
Gillian is not affected by the new restricted annual allowance because her net income is less than £110,000.
Example 2 – Steven
Steven has annual income, excluding pension contributions of £115,000. Between Steven and his employer, £30,000 gross is paid into his pension each year.
Steven is potentially affected by the new rules and must calculate his adjusted income to see whether his annual allowance is restricted. His adjusted income is £145,000 (£115,000 plus £30,000).
As Steven’s adjusted income is less than £150,000 he is not affected by the reduction in annual allowance.
Example 3 - Peter
Peter has annual income, excluding pension contributions of £145,000. Between Peter and his employer, £35,000 gross is paid into his pension each year.
Peter is potentially affected by the new rules and must calculate his adjusted income to see whether his annual allowance is restricted. His adjusted income is £180,000 (£145,000 plus £35,000).
As Peter’s adjusted income is more than £150,000 his annual allowance is reduced by £1 for every £2 by which his adjusted income exceeds £150,000. This means his annual allowance is reduced by £15,000 to £25,000. This reduced annual allowance will apply from 6th April 2016 onwards.
This change was announced in the Conservative Party manifesto ahead of this year’s General Election, so doesn’t come as a complete surprise. However, the calculations are complex and difficult because total income is not known until the tax-year end, by which time pension contributions for that tax-year will have been paid. People who earn more than £110,000 and pay pension contributions, should consider speaking to a financial adviser.
PENSIONS LIFETIME ALLOWANCE REDUCED TO £1M
It is confirmed that from April 2016, the maximum amount that pension savers will be able to get out of their pension, without triggering an extra tax charge, will reduce from £1.25m to £1m. From 6th April 2018, the lifetime allowance will be indexed in line with CPI.
Claire is 45-years-old and plans to retire at age 60. Her pension fund is currently worth £500,000.
Assuming that Claire’s pension fund grows at 7% a year (after charges) and the lifetime allowance grows in line with the government’s CPI target of 2% a year from 2018, by 2030 (when Claire is 60), the value of her pension fund and the lifetime allowance will be as follows:
Claire’s pension fund £1,380,000
Lifetime pension allowance £1,268,000
This means that Claire’s fund exceeds the allowance by about £112,000. She will have to pay 55% tax on this excess.
£1m might sound like a lot of money but it would only buy a guaranteed index-linked lifetime income of about £30,000 for a 65-year-old assuming the pension was paid at half that level to their spouse on death (Source: Money Advice Service 9th July 2015, postcode EH42, spouse three years younger than main annuitant and both in good health).
Also, as the example above illustrates, the limit is measured at retirement meaning that savers need to think about what their fund and the limit will be when they take their money out rather than the value today.
Savers who are uncertain whether they should pay more money into their pension or opt for the current allowance instead, should consult a financial adviser.
MAKING ISAS MORE FLEXIBLE
It was announced in the March 2015 Budget that savers will be able to withdraw and replace money from their cash ISA within the same tax-year without it counting towards their annual ISA subscription limit.
The July 2015 Summer Budget will extend this flexibility to cash held in stocks and shares ISAs from April 2016.
Joe has £30,000 in his cash ISA that he has built up over a number of years. On the 25th of November 2015 (in the 2015/16 tax-year), Joe withdraws his £30,000 savings to pay for a new conservatory for his home. In February 2016, Joe receives a £50,000 lump sum from his pension and wants to reinvest this tax efficiently.
As he is no longer earning, the most he can put into his pension in each tax year is with tax relief is £3,600 (£2,880 net of tax relief).
However, the new ISA rules will allow him to use £30,000 of his pension lump sum to replenish the £30,000 he took out of his cash ISA in November 2015. He must do this before 6th April 2016.
In addition, assuming he has not used his normal ISA allowance for the 2015/16 tax year, Joe can put another £15,240 into his ISA before 6th April 2016.
In total, Joe can put £45,240 of his pension lump sum back into an ISA (£30,000 in a cash ISA and the other £15,240 in either a cash or stocks and shares ISA) and, assuming he is under 75, £2,880 into a pension. This means that Joe can reinvest most of his lump sum tax efficiently in the tax-year 2015/16.
This is a useful new allowance for people that need access to their savings, but who will be able to replenish the money they take out within a short period.
BUY-TO-LET MORTGAGE INTEREST TAX RELIEF
Under current rules, buy-to-let landlords can deduct finance costs (mortgage interest and interest on loans to buy furnishings and cover fees) from rental income received, meaning that they receive tax-relief on these costs at their highest marginal rate of income tax of up to 45%.
From April 2017, the rate of relief allowed on these costs will be restricted from the landlord’s highest marginal tax rate to the basic rate of income tax – currently 20%.
The change will happen over four tax-years:
- In 2017/18, 75% of finance costs will remain deductible at the marginal rate and 25% will be deductible at the basic rate
- In 2018/19 50% of finance costs will remain deductible at the marginal rate and 50% will be deductible at the basic rate
- In 2019/20 25% of finance costs will remain deductible at the marginal rate and 75% will be deductible at the basic rate
- In 2020/21 all finance costs will receive tax relief at the basic rate of income tax
This change makes buy-to-let investments less tax attractive than at present where they are subject to tax on rental profit, subject to Capital Gains Tax when sold and part of the landlord’s estate on death. This change will effectively increase the amount of tax paid on rental profits.
This change may drive investors to seek out more tax efficient investments such as pensions and ISAs.