Income tax planning

Tax planning for higher earners should be a year round discipline rather than making hasty decisions to beat impending deadlines. An effective rate of income tax of 60% was introduced from the start of the 2010/11 tax year as a result of the gradual reduction in the personal allowance by £1 for every £2 of taxable income above £100,000.

There are many elaborate schemes in place which have the aim of reducing liability to Income Tax. There are also more obvious planning ideas which can be utilised to achieve this.

Five ways to reduce your level of income subject to income tax:

(1) If considering starting to draw an income from pension funds, the normal route is to draw the maximum possible tax-free lump sum entitlement and use the rest of the fund to provide an income. This income would normally be subject to Income Tax at your highest rate. However, an alternative would be to utilise only part of the pension fund and use the tax free cash entitlement to instead provide an income. This can be done on a regular basis until all of the tax-free entitlement has been exhausted.

This route also has the benefit of keeping a higher proportion of the pension fund with more tax-advantageous death benefits, for longer.

(2) If you have investments which are subject to Capital Gains Tax, such as OEICs or Unit Trusts, regular encashments can be made to provide you with income. Provided any capital gain within the amount you receive is within the annual CGT allowance, there would be no further tax to pay on the ‘income’.

(3) Encashments from Investment Bonds within 5% a year of the original investment amount (over a 20 year period) result in income tax deferral. This is because the encashments are deemed a return of your original investment, rather than income or gains. At the end of the 20 year period, any tax due is payable at your highest rate of tax at that time. Savings can be made if your highest tax rate is lower at that time.

(4) Any income generated from assets held within an ISA wrapper, or regular encashments made from these wrappers, are not subject to Income Tax or Capital Gains Tax (other than the non-reclaimable tax credit on dividends).

(5) If your spouse is not subject to tax, investments could be transferred into his or her name to allow income which may otherwise be taxable to be paid tax-free (or almost tax-free in the case of any dividend income).

Obviously everyone’s situation is different.Tax is not the only consideration and an option which may be efficient from an Income Tax point of view may not be advisable from an investment point of view, for example. These scenarios should only be considered as part of an overall financial plan.

For more details, please contact Amanda Wilson on amanda.wilson@carbonfinancial.co.uk