Add up the advantages of not wasting on tax

offshore investment marketplacePAYING taxes, like death, is one of life’s more unpleasant certainties. No one likes to see their hard-earned cash lining the Treasury’s coffers.

But while death is unavoidable, paying too much tax is something we can laugh in the face of.

Nationally, £5.66bn in wasted tax is set to wing its way into the Chancellor’s treasure trove. No wonder Gordon Brown looks like the cat who got the cream.

Why as a nation we seem to enjoy handing our money over to the Government is a question that is exercising IFA Promotion, the organisation that represents independent financial advisers, as it prepares to launch its annual TaxAction campaign.

The aim of the initiative is to educate consumers on how they can pay less tax.

But 13 years after it was first launched, the message doesn’t seem to be getting through.

IFA Promotion says this can partly be explained by more onus falling on the individual to claim tax credits and sort out their tax affairs. A combination of laziness and ignorance are also to blame.

Tax specialist Chris Hodgson said he too is bewildered by how many people fail to fight back against the taxman. People will look at bank accounts and shop around to get an extra 0.1% on their savings whereas if they invested properly and maximised their tax breaks, they could, for example, get 4% tax free on an ISA.

Chris said, “I suppose for many it is the hassle of opening an account. Some are discouraged from shopping around as the new money-laundering regulations mean you now have to produce your passport and driving licence, etc. It is a small thing but it is enough to put many off.

“Also, a lot of people don’t have large amounts of money to invest and when they see a 0.3% or 0.1% difference in an account they just think it represents £5 or £10 a year and feel they can’t be bothered to do anything about it.

“What they don’t see is that over the long term these amounts add up.”

Chris said inheritance tax (IHT) – currently levied at 40% on all assets above £263,000 – is the biggest issue facing most people, and adds that he has never been busier in this area.

So what are the main issues that will help you save tax?

Life policy payouts:

The payouts from the majority of life insurance policies are free of personal tax. But that doesn’t mean you can forget about the issue of tax altogether where your life cover is concerned.

When you die, the proceeds of your life insurance policy are paid to your beneficiaries, and may be subject to IHT, leaving your heirs with a potentially large tax bill.

Every £263,000 of taxable assets you leave behind could create an IHT bill of £105,200 for your heirs to pay.

Transfers between spouses are free of IHT. And so no IHT will be due if you leave your assets to your husband or wife. Of course, this may merely postpone the problem until the last surviving partner dies.

There are a host of ways in which you can minimise the amount of IHT your heirs will face. For example, it may be possible to arrange your life insurance in such a way that the proceeds remain outside your estate, and can be used to meet the IHT lia-bility arising from other assets. Life insurance is not only a way of protecting your family, but can also be a tax-efficient way to save for the future.

Some life policies are structured as bonds, which allow you to fund the policy with a single lump-sum investment, and if you want you can draw a regular income. Within certain limits this income is free of immediate tax and if you are a basic rate payer, may remain free of all tax.

Offshore life insurance bonds, based in tax havens like Jersey or the Isle of Man, can be used to defer UK residents’ income tax until the investor falls to a lower tax bracket.

Personal pensions:

Pensions are a good product for those who are tax-conscious, because they boost the value of every £1 you invest – as you receive tax relief of at least 22%.

Many other products make you wait until your first income payment – or even until the plan matures – before you see tax benefits.

Pension contributions give you tax relief at the highest rate you pay. For a 40% taxpayer, that means for every £100 invested, the net cost to you is only £60.

But the taxman strictly limits the proportion of earnings you can put into private pensions, such as occupational schemes, stakeholder and personal plans, each year.

If you are a member of an occupational pension scheme, you can normally contribute up to 15% of your earnings personally on top of what your employer pays. Depending on your circumstances, you can also contribute to a stakeholder pension plan to provide additional benefits.

Since April 2001, the rules for contributing to private plans, such as personal schemes, have been relaxed and you are able to contribute up to £3,600 per annum gross into a pension every year regardless of whether you have any earnings or not. Where your annual contributions exceed £3,600, there are percentages of your income which you can invest in “deemed contribution” schemes such as personal pensions or a stakeholder. This ceiling rises gradually as you get older.

At retirement, up to 25% of the personal pension or stakeholder fund can be used to provide a tax-free cash sum. The remaining fund must then be used to provide an income which is taxed as earned income.

Individual Savings Accounts (ISAs):

These currently allow you to save up to £7,000 a year without you having to pay tax on either the income that investment generates or its capital growth. You can choose ISAs which invest your money in a cash account, stocks and shares, or a with-profits life insurance policy.

Bonds: When you buy a bond, you are lending money either to the UK Government or to a company in return for a fixed rate of interest. Government bonds – known as gilts – are a safe form of investment, because you know you will get your capital back at the end of the gilt’s term, plus regular income payments.

Your money is at risk only if the UK Government defaults on its loans – which is very unlikely.

Bonds issued by companies work the same way. If you select a big company with sound finances, the risk involved should be only a little higher than when buying a government bond. Corporate bonds and gilts can be wrapped inside an ISA to save tax.

Capital Gains Tax (CGT): The return you get from many investments divides neatly into two parts. First, there are the income payments which the investment produces and, secondly, its capital growth.

With an equity investment, for example, the shares you own will produce income from the dividends and – with luck – capital growth from a rising share price.

The Government taxes both elements of this gain, the first through income tax, the second through CGT, which is charged at up to 40% if your taxable gains total over £8,200 in the tax year.

The longer you hold the assets, the less portion of tax you should pay due to what is known as “taper relief”. The taper reduces the amount of the chargeable gain according to how long the asset has been held.

Source: icWales


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