The following notes cover some of the aspects which were announced in the Budget (and Pre-Budget report) 2008, which will have effect from 2008/09 tax year and have particular effect on Financial Planning and Wealth Management matters.
1. Income Tax
There have been a number of changes to the Income Tax rates and relief’s.The 10% rate which used to apply to the first £2,230 of all earnings will now only apply to the first £2,320 of savings income. This will only apply to people who have none savings income which is less than £2,320.
The basic rate of tax reduces from 22% to 20%. Because most pension contributions are now paid net of basic rate tax, the unintended consequence of this reduction could mean that the amount invested in a pension could reduce. For example if you currently contribute £780 then the pension provider adds 22% and invests £1,000 on your behalf. In future you will need to increase your contribution to £800, with the Pension provider adding 20% so your pension investment can be maintained at £1,000. The power of compound interest, means if you allow your pension contributions to reduce in line of basic rate tax, a 40 year old planning to retire at 65 may need to defer his plans by six and half months!
Another unintended consequence of the reduction in the basic rate of tax is that Charities which are able to reclaim your tax will similarly be 2% worse off. The Chancellor has ‘generously’ extended the ability to reclaim 22% for charities for a further three years.
2. National Insurance Contributions
The upper earnings limit is to be raised by £5,200 to £40,040 per annum. An employee pays NIC at 11% up to the upper limit and 1% there after. The effect of this change means that anyone earning over £40,040 will in future pay an additional 10% on £5,200 – or an extra £5,200 pa. Employers NIC have remained broadly similar, but it means that there has never been a better time for an employee to consider ways in which NI can be avoided.
One of the most popular and easy to accomplish is by means of ‘salary sacrifice’. This procedure simply involved an employer paying funds directly into a pension plan rather than paying it as a salary or bonus that would be otherwise due. No NIC are paid on pension contributions and the effect is that a generous employer could invest significantly more into a pension arrangement at no additional net cost.
After the massive changes in legislation in 2006 (so called Pension Simplification) it is pleasing to note that there are no further major changes to the pension world this year. A further nail was put in the coffin of the so called ‘family pension’ which at one time had been mooted as a possibility to enable funds to be passed down generations through personal pension plans. It is interesting to note that it is still possible achieve this, in some limited circumstances, particularly where family are employed in a family business.
4. Individual Savings Accounts (ISA)
If you have taken full advantage of the ISA (and former PEP) rules since their introduction, you would have built up some significant tax efficient funds. In 2008/09 the maximum that can be invested in an ISA will rise by 3% to £7,200. This relatively small increase is at least a step in the right direction, but of more value is the fact that the archaic ISA rules are to be relaxed. It will in future be much easier to have a mix of equity and cash based ISA’s and it will even be possible to transfer existing cash ISAs into equity based ISAs.
Funding ISAs is an excellent alternative to funding pension plans. Although you don’t get tax relief on the money invested, you do achieve much greater flexibility and of course with the relaxed pension contribution rules it is possible to transfer ISA funds into Pension funds at a later stage and effectively achieve the best of both worlds.
To take maximum advantage of the tax efficient nature of ISAs we highly recommend investments are made at the beginning of the tax year rather than waiting until the end.
5. Other Investments
Investment which are not protected by a tax free wrapper such as an ISA may be subject to Capital Gains Tax. CGT will in future be levied at a flat rate of 18% on sales of investments, where the ‘profit’ is greater than the annual allowance of £9,600. Wherever possible it makes sense to make full use of the annual allowance as this provides the opportunity to ‘rebase’ investments each year. In the right circumstances growth on a portfolio of investments can generate ‘tax free income’ by careful use of that allowance.
The Fiducia Mastertrust account provides an ideal platform to manage ISA and CGT allowances, but of course ensuring that the ‘tax tail does not wag the investment dog’ is of paramount importance.
6. Inheritance Tax
It has been confirmed that the new measures effecting IHT which were announced in the pre-budge report will go through to the Finance Bill 2008. The change that was announced means that each individuals nil rate band (ie the amount of an estate on which IHT is not payable – which will increase to £312,000) may be inherited by a surveying spouse. This means that for example the first to die may pass all of his assets to his widow. There is no IHT to be paid on a transfer of assets between spouses and then when the widow dies she may effectively ‘double up’ the nil rate band that would otherwise apply to her.
Some commentators have suggested this avoids the need for ‘nil rate planning’ within a will which was a mechanism to ensure that the first deceased’s nil rate band was used, usually by passing assets into a trust. Shortly after the pre-budget report in October 2007, there was speculation in the press that some wills would need to be rewritten as a result.
As is so often the case, with the benefit of further consideration many legal advisors now recommend that nil rate band provisions are maintained within existing wills on the grounds that they can either be ignored or used as the circumstances dictate at the time. There are some limited circumstances where a nil rate band trust provision could be useful and some advisors are suggesting that they should be included within new wills.
This is but a brief run through of the major points in the budget which will affect our Financial Planning clients. There were many more points which may need to be addressed in specific circumstances and we will be raising these individually with our clients and their legal and taxation advisors. Should you have any queries with regard to the above notes or indeed other aspects of the March 2008 budget, please get in touch immediately.