Avoiding the age allowance trap?
|Tax | Income Tax
Asked by rafferty, submitted
09 March 2010.
The "age allowance trap".
If income is over £22,900 (for the tax-year 2009-2010) the additional age allowance for those over 65 reduces by half of the income over that limit, i.e. it reduces by £1 for every £2 of income over £22,900. So those between 65 and 74 with an income over £28,930, iirc, will lose the entire extra allowance - resulting in an effective tax rate of 30% between those points.
What strategies should be considered in addition to considering the income of spouses to minimise the impact of this and what investments should be considered to make best use of the CGT allowance?
Answered by Justin on 10 March 2010
Thanks for raising an important point. As you mention, the effective 30% tax rate is due to a combination of 20% tax and losing £1 of personal allowance for every £2 of income between £22,900 and £28,930. For example, £100 of income would be taxed at 20% (£20) and also result in £50 of lost personal allowance which is then taxed at 20% (£10) making an extra £30 of tax in total (30%).
The simplest way that most couples can avoid this scenario is to hold any savings and investments between them so that neither partner strays beyond the £22,900 limit – as you’ve pointed out. Otherwise, the following suggestions could help.
One of the most effective ways of avoiding/reducing this problem is to hold savings and investments within individual savings accounts (ISAs). ISA income does not need to be entered on a tax return hence has no impact on the age allowance. An added advantage of using ISAs is that you should be able to keep most shares and investment funds you may already own by simply selling and repurchasing within an appropriate stocks & shares ISA, subject to the current annual contribution limit of £10,200 (just be careful you don’t trigger a capital gains tax liability when selling the original investments).
Another option, if you don’t require a regular income, is NS&I Index-Linked Savings Certificates paying a tax-free return above inflation over either three or five years.
Capital growth investments that make use of annual capital gains tax allowances can be very tax efficient, but usually entail some risk and won’t provide a regular income, so you need to comfortable that they’re appropriate. You could use shares, unit or investment trusts for this purpose provided they target growth and not dividends.
Zero dividend split-capital investment trusts have been popular in the past for this kind of purpose. Despite some major problems between 2000 and 2002 the market has since settled, but it’s vital you understand what you’re buying so I’d suggest seeking specialist advice if necessary.
If you prefer less risk then you could consider capital protected plans where any returns are classed as capital growth and not income. They typically run for around five years and link returns to a stockmarket index, while protecting your initial investment. However, beware, as some of these plans are becoming increasingly complicated (which increases the risk of buying something that isn’t what it seems) and they’re only as safe as the financial companies providing the underlying guarantees – several protected plans took a big hit when up when Lehman Brothers went under.
Finally, I have seen insurance companies highlighting investment bonds for this purpose, because you can draw up to 5% of the initial investment each year without it being classed as income. On the downside the underlying investments are taxed internally at basic rate, reducing any tax saving, and any profit you make on the bond when you sell counts as income for the purpose of your age allowance in that year. I’d view these as a last resort.
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Readers' Comments (3) - To post a comment please register or login
Comment by webwiz at 8:19am on 12 Mar 2010:
IMHO Equity ISAs actually provide no tax shelter to most investors since dividends are taxed even if in an ISA and few investors are lucky/clever enough to make capital gains in excess of their allowance. Most people should use their full cash ISA allowance rather than waste it on equities. As for the other 50%, bonds do have a tax advantage and if one does not fancy bonds then there is nothing to be lost in using the other half for equities even if there will probably be no advantage either.
Comment by justin at 7:41pm on 12 Mar 2010:
I agree in so far as basic rate taxpayers don't save any tax on dividends in an ISA - although higher rate (40%) taxpayers save paying a further 25% tax on the dividend received (technically 32.5% on the 'gross' dividend). And you're quite right,interest bearing assets such as cash and corporate bonds held in an ISA save tax for all taxpayers.
But in the context of the age allowance basic rate taxpayers would still benefit from holding shares/equity funds in an ISA (assuming they want those investments anyway) because the income does not need to entered on a tax return, hence it doesn't affect their age allowance - as it might outside of an ISA.
I guess the key is not paying any more to hold investments in an ISA than you would if you bought them conventionally. This shouldn't be an issue for fund ISAs and if you want to hold shares then stockbrokers such as iii.co.uk and Alliance Trust Savings offer a self-select ISA wrapper for free with low dealing costs.
Comment by rafferty at 12:59pm on 13 Mar 2010:
Thanks Justin for a very complete reply.
Seems odd that someone who earned well under the point where they’d pay higher rate tax when they were working could retire with just a half salary pension plus the basic state pension and then be subject to an effective marginal rate of 30%.
Would agree with webwiz that it needs to be more attractive for basic rate tax payers to hold equities in an ISA than at present. More so when it can be difficult to anticipate the usefulness or otherwise of a S&S ISA years in advance.