When It Comes to U.K. Taxes, Sweat the Small Stuff

(Bloomberg Opinion) -- In an age of mindfulness, we are regularly told not to sweat the small stuff. We are implored to concentrate on what is important and meaningful, like family, friends, health and a good work-life balance.

There is one time of year, though, when the details do matter. It’s the end of the tax year, which, for historic reasons, falls on April 5 in the U.K. This is the cut-off date for using tax allowances and for making pension contributions to claim relief — choices that will affect what you’ll have to pay by the next tax deadline of Jan. 31.

The situation this year is more complicated: Some people have experienced sharp reductions in income; others may have made small fortunes from the robust recovery in global markets. Whatever your experience, you’ll want to keep in mind some tax pitfalls to avoid as well as some opportunities to reclaim cash.

Don't leave it to the last minute. If you are planning to make a withdrawal from or a contribution to your pension, especially if it is to optimize your tax allowances, bear in mind that the tax year unhelpfully ends on Easter Monday this year. So, any arrangements with your broker or financial advisor need to be sorted out well before the holiday weekend.

Use your income and capital gains tax allowances. Most people don't pay tax on the first 12,500 pounds ($17,660) of income or the first 12,300 pounds of any capital gain they have made. (Don’t forget: If you were fortunate enough to profit from trading GameStop or Bitcoin, the U.K. will want its cut of any gains above the threshold.) Income tax allowances can be transferred between spouses, as can assets with a capital gain.

If you have some control over how much income you draw, because you run a business or have retired, you might be able to manage your earnings to take full advantage of your allowance. If you need more income than the basic allowance, earnings of up to 50,000 pounds are taxed at 20%. Thereafter the rate doubles to 40%.

Be careful how much you pay into your pension. Ordinarily, pension contributions offer tax relief at your marginal income tax rate. So if you are a 40% taxpayer, every 60 pounds you pay into your pension is grossed up to 100 pounds by the tax relief. This is so valuable that contributions are capped at 40,000 pounds per year (including the value of the relief). If you pay any more into your pension, the government will start clawing back the tax relief. This can leave the well-paid and unwary, who may have automatic contributions set up, with a chunky tax bill.

If you are a very high earner, the government has a complex formula progressively reducing your annual pension contribution allowance. The more you earn, the greater the risk that your annual allowance might be cut. In the worst case, your allowance could be reduced by 90% to just 4,000 pounds, and any contributions beyond this will have the tax relief reclaimed. This can sometimes result in an unexpected tax bill in excess of 15,000 pounds — a shock for those who presumed they were entitled to the full 40,000-pound allowance.

Fortunately, if your net taxable income is less than 200,000, pounds this is unlikely to apply to you. For others, unused allowances from previous years can be brought forward, although it is a fiddly area that usually requires professional financial advice.

Reclaim your personal income tax allowance by making a pension contribution. Those fortunate enough to be earning in excess of 100,000 pounds will find their 12,500-pound personal income tax allowance is progressively lowered. The allowance disappears altogether once earnings hit 125,000 pounds.

This can sting as the combination of paying 40% regular tax and progressively losing your annual allowance means your effective marginal tax rate rises to an eye-watering 60%. However, by making a pension contribution before the tax deadline, you can effectively decrease your earnings subject to tax, ideally back to below 100,000 pounds, and get your personal income tax allowance back.

Pay attention to another deadline. On March 3, Chancellor of the Exchequer Rishi Sunak will present the 2021 U.K. budget to Parliament. His challenge will be narrowing a fiscal deficit estimated at 400 billion pounds. There have been many hints about tax hikes. A wealth tax appears less likely, but changes to capital gains tax and inheritance tax are both distinct possibilities.

With capital gains, it is possible that the rate of taxation will rise, possibly substantially, while the annual tax relief allowance might fall. This would be to bring the rates of taxation on earned income and capital gains closer together.

The situation with inheritance tax is more complicated. There are currently generous allowances for making gifts in your lifetime or using business structures to protect assets from being taxed. However, a cross-party group of MPs has made a series of recommendations to tighten these up.

Right now, it’s possible to gift up to 325,000 pounds in one go without paying any tax, provided the donor survives for seven years after the gift is bestowed. The MPs have recommended limiting tax-free gifting to 30,000 pounds per annum and applying a tax of 10% to any gifts over that threshold. The upside would be a lower rate of tax on one’s estate after death.

It would be wise to ensure that any current capital gains or gifting plans were completed before the March 3 announcement.

Nothing can take away the stress of the end of the tax year, but sweating the details to save cash can go a long way toward easing the pain.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stuart Trow is a credit strategist at the European Bank for Reconstruction & Development. He is also a pensions blogger, radio show host and member of numerous retirement, finance and audit committees.

©2021 Bloomberg L.P.