2021/22 Tax Year Allowances
As we approach the end of the 2021/22 tax year, it is useful to review the annual allowances available to individuals.
In the run up to each budget, headlines are littered with predictions of tax rises and speculation as to which areas of legislation might be revisited. Most of the post-COVID changes have been relatively muted, but with UK government debt standing at 103.6% of GDP (£2,223 Bn) as of March 2021, there are increasing calls to cut spending, raise taxes, or a combination of both.
It is therefore more important than ever to ensure you understand what your personal tax allowances are, and whether you can make use of them.
In this article, we have highlighted five of the most commonly discussed allowances.
Personal Allowance – £12,570
The first £12,570 of income in the 2021/22 tax year will fall within an individual’s Personal Allowance and be free from income tax. This figure is set to be frozen until 5th April 2026, having previously increased in line with inflation.
It’s worth noting that for individuals with adjusted net incomes over £100,000, the Personal Allowance is reduced by £1 for every £2 it breaches that threshold. This results in an effective 60% Income Tax rate for individuals with adjusted net incomes between £100,000 and £125,140.
For individuals who do fall into this ‘Personal Allowance trap’, it is possible to reduce your adjusted net income by making pension contributions. This can often work out to be extremely tax efficient as you will obtain tax relief on the pension contribution as well as benefit from having some or all of your personal allowance reinstated.
Another consideration for married couples is to ensure that income producing assets are held in a way which makes use of both partners’ allowances.
ISA Allowance – £20,000
ISAs (Individual Savings Accounts) are a fantastic tool to shelter assets from Income Tax and Capital Gains Tax. As the rules currently stand, an individual can contribute up to £20,000 into ISA products each tax year. Investments held within a Stocks and Shares ISA ‘wrapper’ will grow free of tax and can be withdrawn without triggering a tax liability.
There are two ISA products where the £20,000 limit is not applicable:
Junior ISA – Is available to children under the age of 18 and has a reduced annual limit of £9,000.
Lifetime ISA (LISA) – Is a product designed to be used either towards a first property purchase, or a retirement savings vehicle which benefits from a 25% government bonus. There is an annual LISA limit of £4,000 which counts towards the overall £20,000 ISA limit. Only individuals aged between 18 and 40 can open a LISA, however you are able to make contributions until your 50th birthday. You cannot access the LISA funds without penalty unless you are purchasing your first property, aged 60+ or terminally ill. It is important to understand the terms of LISA products, such as limitations on the values of first house purchases, to avoid incurring an unexpected 25% penalty.
Pension Annual Allowance – Up to £40,000
The amount that an individual can contribute into pension without suffering an ‘annual allowance charge’ is capped at £40,000 (gross) each tax year. There are several caveats to this rule and this area of pension planning can involve some complex calculations. The main points to be aware of are as follows:
Pension contributions benefit from tax relief (and potentially National Insurance savings) at the point you make the contribution. Any contributions that are invested will be able to grow free of tax. With legislation as it currently stands, pensions sit outside of your estate for Inheritance Tax purposes, making them an extremely valuable tool to those that might be facing an IHT bill upon death.
It’s important to remember that any capital contributed into pension wrappers cannot be accessed until age 55, with this rising to 57 from 2028 and likely to increase in future years.
Capital Gains Tax Allowance – £12,300
Capital Gains Tax (CGT) rates have been the subject of much speculation since the Office of Tax Simplification issued a paper in November 2020 recommending that the government should consider aligning Income Tax and CGT rates.
An individual has a personal CGT allowance of £12,300 in the 2021/22 and 2022/23 tax years and capital gains that fall within this threshold are exempt from CGT.
Gifts between married couples are exempt from CGT which often presents a planning opportunity where one partner is not making use of their CGT allowance.
Dividend Allowance – £2,000
An individual does not need to pay tax on the first £2,000 of their dividend income, regardless of the level of their non-dividend income.
For business owners, this presents an opportunity to extract cash from the business free of tax by declaring dividends.
Investments that are taxable and not held within a tax ‘wrapper’ such as a pension or ISA may also generate dividends. It’s important to regularly review whether these are structured in a tax efficient manner, particularly for married couples who will each have their own dividend allowance.
Dividends in excess of the Dividend Allowance will be subject to the below rates in the 2022/23 tax year, a 1.25% increase from the current position for each band:
Basic Rate Taxpayers – 8.75%
Higher Rate Taxpayers – 33.75%
Additional Rate Taxpayers – 39.35%
Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation which is subject to change. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate Tax Advice.