In association with Close Brothers Asset Management
High earners face a unique set of challenges when it comes to financial planning. With those in the top tax bands facing high tax rates on both capital gains and dividend income, high earners can potentially face large tax liabilities from their investments.
Fortunately, there are a number of ways that high-income individuals in the UK can grow their wealth tax-efficiently. Here are some financial planning tips that could help high earners reduce their investment-related tax liabilities significantly.
Make the most of your pension allowances
One of the most effective ways for high earners in the UK to build wealth tax-efficiently is to save into a pension. Within a pension, capital gains, and dividend income are tax-free. In addition, contributions come with tax relief. This is essentially a reward from the government for saving for retirement.
Tax relief is paid on your pension contributions at the highest rate of income tax you pay. So, higher-rate taxpayers receive 40% tax relief, while additional-rate taxpayers receive 45% tax relief. This means that a £1,000 pension contribution will only cost you £600 if you’re in the higher-rate tax band. If you’re an additional-rate taxpayer, a £1,000 contribution will only cost you £550.
For 2020/2021, the standard annual pension contribution limit for tax relief purposes is £40,000. However, if you are considered to be a ‘high-income individual’ and have an ‘adjusted income’ of more than £240,000 per year, and a ‘threshold income’ of more than £200,000 per year, your annual allowance will be tapered by £1 for every £2 you are over the adjusted income figure.
High earners can potentially contribute more than their tapered annual allowance by taking advantage of carry forward rules. The way carry forward rules work, is that you are allowed to make use of any annual allowance that you have not used in the three previous tax years, as long as you meet certain criteria. Carry forward is particularly useful if your income varies from year to year. For example, if you are self-employed and your income changes every year, carry forward rules could help you contribute more into your pension in a year in which your income is higher.
One issue for high earners to be aware of in relation to pensions, is the Lifetime Allowance (LTA). This is the total amount of money you can build up in your pension accounts without paying extra tax charges. Currently, it stands at £1,073,100. If you go over the LTA, you will pay a tax charge on the excess whenever you take income; withdraw a lump sum from your pension; or reach the age of 75 without having taken any benefits. There are several strategies that high earners can employ to avoid breaching the LTA such as redirecting retirement savings into a spouse’s pension.
Save and invest within ISAs
Saving and investing within an ISA is another tax-efficient strategy for high earners to consider. Like pensions, ISAs allow investments to grow free of tax.
The annual allowances for ISAs are quite generous today. The Stocks and Shares ISA, for example, has an annual allowance of £20,000. This means that a couple could potentially save £40,000 per year tax-free. This money can be accessed at any time.
The Lifetime ISA, which is open to those aged 18 to 40, has a lower annual allowance of just £4,000. However, contributions into this ISA come with a 25% top-up from the government while you’re under the age of 50. This means that if you invest the full £4,000, you’ll receive an additional £1,000. The downside of this ISA is that it is more restrictive than the Stocks and Shares ISA. You cannot access your funds until you turn 60 or purchase your first property.
Consider venture capital schemes
Finally, high earners who are comfortable with high levels of investment risk may also want to consider venture capital schemes. These are investment schemes that have been set up by the UK government to promote investment into small, early-stage companies. They offer very generous tax breaks.
One such scheme is the Enterprise Investment Scheme (EIS). This scheme is designed to encourage investment into early-stage companies that are not listed on a stock exchange. It offers investors a range of tax breaks, including income tax relief of 30%; no Capital Gains Tax (CGT) on gains realised on the disposal of EIS investments provided the investments are held for three years; and CGT deferrals if proceeds are invested in qualifying EIS investments.
While venture capital schemes can help high earners reduce their tax liabilities significantly, it’s important to understand that due to the high-risk nature of investing in early-stage companies, they are not suitable for everyone. Only those who can afford to take the risk should consider these investment schemes, and it’s a good idea to seek the opinion of a qualified expert before investing.
Partner with a financial adviser
Overall, there are plenty of ways for high earners to save and invest for the future tax-efficiently. Putting a tax-efficient savings plan in place is crucial, because the difference between pre-tax and post-tax investment returns can be substantial.
Financial planning can be complex at times due to all the different allowances. This is particularly true for high earners. If you are unsure about the best approach to take, it’s a good idea to consult a qualified financial adviser. An adviser will be able to guide you through the complexity and ensure that you make the most of the various allowances available to you.
Capital at risk. Any tax benefits will depend on your personal tax position and rules are subject to change.
To find out more about how Close Brothers Asset Management can help you with your financial planning needs, visit their website.