2009 was a turbulent year for the financial world on many levels. Economic forecasts, banking
regulation and interest rates dominated our headlines. Last year also saw the introduction of a number of important financial changes that will impact on some of us at a more personal level. We will review some of these changes and how they might affect you. Then you can decide if you need to give your finances a health check this new year.
I’ve heard there are going to be changes to the tax allowances for high earners. Can you tell me more?
In last April’s Budget, the Chancellor announced a new ‘additional rate’ of tax for those who have an income in excess of £150,000. This rate is expected to be 50% or 42.5% for dividend income. Ultimately, this means that if you fall into this income bracket then you will receive just 50p for every £1 you earn over £150,000.
In addition to this new tax rate, measures were also announced to reduce the tax-free personal allowance for those with incomes in excess of £100,000. Currently, the personal allowance system means that we all receive the first £6,475 of income tax-free. However, from April this year, the personal allowance will be reduced by £1 for every £2 of income over £100,000 until it is completely eliminated. So for example, if you are a dentist with an income of £110,000, your allowance will be reduced by £5,000 to £1,475 because your income exceeds the £100,000 threshold by £10,000.
So, if you’re affected by these changes you really need to start talking with your financial consultant now. There are things you can do to minimise the impact – such as reducing your taxable income by making higher pension contributions – but everyone’s situation will be different so seek professional advice.
Haven’t high earners also been hit on pension savings?
Pension savings underwent a major change last year. Historically, the government has offered generous tax benefits to encourage people to save for their retirement. So, up until this year, higher rate taxpayers could receive 40% tax relief on pension contributions. This meant that every £100 invested in a pension fund could cost the pension holder as little as £60.
However, since last April, those with a total income in excess of £150,000 have had restricted higher rate tax relief. In the December pre-Budget announcement, the Chancellor extended this to anyone with a total income in excess of £130,000. The restrictions are complex, but some high earners who pay income tax at 40% (and possibly 50% from April this year) will only be able to get 20% tax relief on their pension contributions. There is currently some protection for pre-existing and small levels of pension contributions, including your NHS Pension Scheme, although further changes are expected in 2011.
Will changes in the lifetime allowance mean I may end up paying tax on my pension fund?
It’s fair to say the lifetime and annual allowances also saw a shake-up last year. The lifetime allowance is the maximum value of all of your pensions (with the exception of state pensions) that you can build up in your lifetime without having to pay extra tax.
If the total value of your pensions is greater than the lifetime allowance, you have to pay tax on the excess at a rate of up to 55%. The annual allowance is a limit on how much you can put into pensions in any year without suffering a tax charge.
Since their introduction in April 2006, the lifetime and annual allowances have been increasing fairly steadily at about 4% each year, and there was every indication that this would continue. However, in his pre-Budget report in late 2008, the Chancellor announced that the lifetime allowance and annual allowances are to be frozen at £1.8 million and £255,000 respectively from 6 April 2010 until 5 April 2016. The legislation to make this happen was enacted this year, and the result of this freeze will be that some people might now end up paying tax on their pension funds.
Given all these changes in the pension planning arena, you may want to start re-thinking how you save for retirement. You could take a more strategic approach utilising ISAs in conjunction with pension plans to maximise tax benefits. Again much depends on your own personal circumstances, but we recommend you investigate further if you are impacted by these changes.
To end on a positive note, one change for the better last year was the announcement that, from April, there will be an increase in the ISA allowance, meaning you can save up to £10,200 in a stocks and shares ISA or up to half in a cash ISA and the remainder in stocks and shares.
With interest rates at an all-time low, this is particularly good news for higher rate tax savers as they usually lose 40% of interest they earn on savings.
So, if you’re going to make any resolutions this new year, we recommend that you make it one that could impact on your future wealth. Seek professional advice on how you can minimise the impact of the changing financial landscape.