Individuals are taxed on their own income and gains, and have their own set of tax allowances. For families, this can lead to allowances being wasted and overall tax bills being higher than they need to be.
Treating the family finances as a collective and getting the most out of the allowances available can serve to boost savings. While most tax allowances can’t actually be passed on to partners, tax relief and taxable income and gains can. The result could be that savings may last longer in retirement and increase the legacy available for future generations.
Doubling up on tax allowances
Savings tax allowances
As a family unit, the pension annual allowance doubles up to £80,000, and it is possible to use a spouse or partner’s ISA allowance to allow tax free savings. This enables a couple to save up to £40,000 a year into ISAs.
What is perhaps less obvious is the ability to top up a spouse or partner’s pension. Thanks to tax relief, saving into a pension between different family members could secure a much better financial future.
For people with larger pension pots, funding their pension has been eroded by cuts in the lifetime allowance and the tapering of their annual allowance. Those affected by the pension funding cut may need to seek an alternative home for their retirement savings. But the most tax efficient solution could lie close to home – by topping up their spouse or partner’s pension.
Contributions are not limited to £3,600, but by the difference in their partner’s current payments and their earnings. That’s potential for up to £80,000 of tax relievable pension savings each year.
But it isn’t just those who have their funding options restricted who may wish to direct their pension saving towards their spouse or partner. There are other reasons why this might make financial sense.
- Where one spouse pays tax at a lower rate than the other, it may make sense to divert pension saving to the one with the highest earnings to take advantage of more tax relief at higher rates. But this should only be considered if it doesn’t affect entitlement to employer contributions from a workplace pension.
- A gross pension contribution reduces the income used to determine eligibility for certain allowances and benefits. Switching funding to the highest earner could not only see an increase in the tax relief available but could also result in allowances being retained. For example, personal pension contributions reduce the income used to test eligibility for the Personal Allowance (reduces when income exceeds £100,000 and Child Benefit (reduces when income exceeds £50,000).
Spreading assets between two pensions and using two sets of allowances when accessing retirement funds, can reduce the tax payable and provide a family with more income in retirement.
£1M pension pot
2 x £500K pension pots
|5% drawdown = £50,000 annual withdrawal||5% drawdown = £25,000 annual withdrawal||5% drawdown = £25,000 annual withdrawal|
|Tax free cash = £12,500||Tax free cash = £6,250||Tax free cash = £6,250|
|Personal allowance =£12,500||Personal allowance = £12,500||Personal allowance = £12,500|
|£25,000 x 20% = £5,000||£6,250 x 20% = £1,250||£6,250 x 20% = £1,250|
|Total tax paid = £5,000||Total tax paid = £2,500|
|Effective tax rate = 10%||Overall effective tax rate = 5.0%|
|Net annual income = £45,000||
Family receives net annual income of £47,500
An additional £2,500
Transferring assets between spouses
There are also other allowances which spouses can use to access their savings tax efficiently.
Everyone has their own annual CGT allowance. A disposal of a jointly owned asset would mean that two allowances could be used to offset any capital gains.
And it’s possible to transfer assets between spouses without creating a tax charge. Transfers between spouses are on a ‘no loss/no gain’ basis, with the second spouse deemed to have acquired the assets at the original base cost. Any gain is deferred until the second spouse makes a disposal. However, this only applies to transfers between spouses and civil partners living together at the time of the transfer. Transfers will be a disposal for unmarried couples and separated spouses.
Not only can this mean that both allowances can be used, but transferring assets to a lower taxpaying spouse could mean that gains in excess of the exemption can be taxed at 10% rather than the full 20%. (18% and 28% tax rates for individuals for residential property and carried interest).
Bond assignment between family members
Investment bonds can also be assigned between owners without creating a tax charge. Bonds are subject to income tax under the chargeable event rules. But there’s no chargeable event when a bond is assigned. The new owner is assessable for all future chargeable gains as if they had owned the bond from inception.
Offshore bonds gains are treated as savings income. So clients with little or no other income may also be able to use their savings rate band and personal savings allowance as a way to extract profits tax free, in addition to their personal allowance.
There’s a 20% tax credit for tax deducted within the fund on onshore bonds which cannot be reclaimed. So gains will never be tax free. However, providing the gain after top slicing doesn’t put you into higher rate tax, there’s no further tax to pay.
Unlike the CGT rules, assignment isn’t restricted to spouses and civil partners. For example, assignments to lower tax or non-taxpaying children is a way for the family unit to benefit from further unused allowances – an ideal option for university funding perhaps. Provided the assignment isn’t for consideration (for money or money’s worth) there’s no immediate tax charge.
How Nelsons can help
Considering finances as a family can boost lifetime savings and make those savings last longer in retirement. Of course, this won’t suit everyone and some will prefer their own financial freedom and control.