As you’ve probably already worked out I’m a few shades different from normal. Mrs YFG has got pretty used to that over the years but one thing she still finds funny is how much I enjoy the new tax year. Every 6th of April is like a mini-Christmas to me. Now before you start calling the authorities that there is a madman on the loose – let me explain why. I’m one of those guys who likes a good deal – a bit like Harry Redknapp without the bulldog and bank accounts. And to me there seems few better deals than the annual ISA and pension giveaways that save investors 000s of pounds each year in saved income and gains taxes. Each 6th of April I’m like a squirrel, burying my nuts out of the grubby hands of the taxman.
In this post I wanted to outline what I do each new tax year and why. And then share a few comments on things that have changed this tax year. This is by no means the “warts-and-all” tax guide which I’m sure has been prepared by people much smarter and less lazy than me. But hopefully it’ll give an example of the things I think about.
What I get up to in the new tax year
Firstly, I max my ISA allowance of £20,000. Unfortunately, there was no increase to this year’s allowance, but given we got a hefty £5k increase the year before, I’m not gonna protest too much. In the past this usually involved me dumping the £20,000 I had saved up in my bank account each year. Now I’m
a lazy layabout on/off worker, I only manage to save up a little bit of cash to chuck into the ISA pot. The rest of the allowance I make up using something called “Bed & ISA”. This involves selling my investments outside of a tax-wrapper and re-buying them in the ISA. Most brokers, including mine, only charge a single transaction fee (or make it completely free) to do this, making it cheaper that manually doing the transactions. When Bed & ISA-ing there are a few things to think about:
- Defusing capital gains – by selling investments that have made some gains, I can use up your Annual Exemption of £11,700 (18/19) so that I don’t have potential CGT to pay. Once within the ISA there are no capital gains, so I won’t have to worry about this ever again. The issue is, if I sell too many assets (c.£45k) or make too many gains after losses (£11,700) I would need to file a self-assessment. You can read more about this at the excellent Monevator website.
- Realising capital losses – on the other token, if its been a rough time for some of my investments I can sell them and claim a capital loss in a self-assessment. This can be used against future capital gains (with a few rules, check out the .gov website for all the gory details). Bear in mind that losses are used first against gains in the same year, so if I’ve also sold assets with a gain, less than the Annual Exemption, I would “lose your losses”.
- Reducing your income tax bill – the other tax element is my income tax bill. There are two elements: (i) interest income; and (ii) dividend income. Starting with interest income, this results from the distributions of Bond funds and ETFs (to qualify, a fund/ETF must, generally speaking, hold over 60% in fixed income or cash-like assets) and from direct holdings of Gilts and Corporate Bonds (bear in mind that you don’t get charge capital gains tax on Gilts, making the need to protect them in a tax-efficient wrapper much lower). Dividend income arises from distributions from equity funds and direct share holdings. There’s also potentially different rules for REITs and you need to consider the effect of withholding tax, generally reclaimable in a SIPP but not in an ISA. All the above also applies for Reporting Funds if you have non-Reporting Funds, as defined, first give yourself a smack on the bottom and then read this, again from the great Monevator website). Interest and dividends are tax differently. Here’s the break-down:
- Interest – you get an interest allowance of £1,000 (basic rate payers) or £500 (higher rate payers). So if your interest income from all your un-sheltered investments (remember, including bank interest) is less than these amounts you won’t have tax to pay! This can make interest paying investments less of a priority to shelter. But…
- Dividends – In dark days gone past dividends would be paid after “deducting” a confusing notional dividend credit. In short, if you were basic rate payer you didn’t have to pay any more tax on your dividends. In 2016/17 the government finally scrapped this mind-bendingly confusing system and gave everyone a dividend allowance of £5,000, now £2,000 (see more on this below) and jacked-up the dividend rates (which are higher than for interest income). If you earn total un-sheltered dividends of less than £2,000 you don’t have tax to pay. This means that if you are likely below the allowance then sheltering dividend paying investments may be less of a priority, but if you are above the allowance then it’s more of a priority.
Back to the real world
So this tax year I’m doing the following:
- Transferring £4,000 in cash from my savings into my stocks and shares ISA.
- Bed & ISA-ing £16,000 of an equity ETF and re-buying it in my stocks and shares ISA. This is because this investment has a substantial gain (the total holding has a gain above the Annual Exempt amount), so by selling I’m defusing part of the gain and lowering the likelihood of having to pay CGT in the future. Secondly, I’m over the dividend allowance, so the distributions from the fund are taxable, and at a higher rate than my interest income.
As another example, I’m helping a family member do the following:
- Bed & ISA-ing £20,000 of a bond ETF re-buying it in their stocks and shares ISA. They don’t have capital gains to worry about at the moment and they are below the dividend allowance, but above the interest allowance. So they don’t pay tax on dividends but do on interest. So moving the bond (rather than equity) investments reduces their tax.
New tax year changes for 2018/19
I wanted to close by writing about some (but not all) of the 2018/19 tax changes.
- The Dividend Allowance – as mentioned above, this is cut from £5,000 to £2,000. Now, I’m gonna try to be calm, but this change has made me very angry. Firstly, the new allowance lasted only one year before being substantially changed. Now investors should be investing for the long-term, so when a major change to taxes is implemented (which it was, in moving from the old dividend credit system) investors are really punished when these changes last in the months not years. This is a particular bad as the allowance accompanied the pension freedoms. Many quick-thinking people may have cashed in investments from their pensions believing that they would not be stung by taxes on their investments but have easy access to them only to see the allowance slashed. I’ve also seen a number of commentators state that the case for S&S ISAs reduced because of the dividend allowance. Those not using their allowance last year might be ruing their choices. But there’s a double kicker:
- The Money Purchase Annual Allowance (MPAA) – has been cut from £10,000 to £4,000. Broadly speaking, this is the annual amount you can put into the a pension after en-chasing a money purchase pension. So, you may have taken money out of pension, using the much touted flexibilities, thinking you won’t pay tax on your dividends and you could always put it back in to a pension at a good rate. Unfortunately, the government changed the rules drastically, again after only one year. Even worse, these changes have been enacted retrospectively from April 2017 (so anyone who hoped to stuff their pockets before the change was in legislation may come up short). I understand why these changes were made (limit pensions re-cycling and to raise tax rates on higher payers) but to investors the continually changing rules make it very difficult to plan for the long-term.
- Auto-enrolment – From April 2018 the automatic (unless you opt-out) rate put into your pension goes up from 1% to 3% (and 1% to 2% employer contribution). There’s been a flood of articles on this in the mainstream media, but given this changes has been on the cards for years its hard to see how this is a shock. Maybe we might see more “shock” when the rate goes up to 5% (3% employer contribution) next year. Hopefully a savvy finance type you are already getting the max contribution from your employer (https://youngfiguy.com/pensions-isas-the-basics).
- The Annual Exemption for Capital Gains nudged up from £11,300 to £11,700. The Personal Allowance also nudged up from £11,500 to £11,850, the bands for higher rate also nudged up. They didn’t for Additional Rate payers, so if you are one, please feel free to sob into your champagne…
- The Buy-to-Let Mortgage Offset reduced from being allowed to deduct 75% of your mortgage interest on BTL income down to 50%. Apparently this is less of shock (maybe because the mainstream media went a bit mad when it was first announced). It’s going down to 25% next year, and finally to 0% in 2020/21 (just to prepare you in-case you drop your monocle in your soup when you read about it in the Telegraph next year).
- Student Loan thresholds are going up. They are nudging up slightly for Plan 1 payers (those before 2012). More importantly, for those post 2012 (with the enormous, higher than commercial rate loans) the threshold is jumping up from £21,000 to £25,000 (as well as the interest thresholds). The threshold had been controversially ‘frozen’ at £21,000 since 2012, and by controversial I mean the Government had made a desirable retrospective money grab, breaking promises given to students. Thankfully, the thresholds are due to increase with average earnings from next year on-wards (well until the Government changes its mind again).
- Finally, the Lifetime Allowance (LTA) is (finally) increasing from £1,000,000 to, wait for it, £1,030,000, in line with CPI (3%). No accounting for the dramatic earlier cuts or the lack of an increase last year. Finally, a little bit of good news for those who’ve done the responsible thing and built a great nest egg for retirement. Unfortunately, there’s no cast iron guarantees that the Government will keep increasing the LTA in line with inflation. So good luck forecasting 10/20/30/40 years into the future.
I hope you’ve enjoyed the post. I also sincerely hope I haven’t made any mistakes or typos – if I have please let me know! Please remember you should do your own research or speak to an authorised financial advisor or financial planner before making any and every investment decision. If you make an investment or decision on the basis of any of the information above you do it at your own risk.
All the best,
Young FI Guy