5 Annual Allowances and Exemptions

The 2021/2022 tax year ends on 5th April, which means that this is also the deadline for using some or all of the annual investment* and tax+ allowances, and exemptions offered to individuals in the UK. Due to the majority of these having a “use them or lose them” status, it is important to explore how annual allowances and exemptions can be used as part of a wider financial plan.

In this article we will introduce five of the annual allowances and exemptions.


1. The Individual Savings Account (ISA) Allowance

The ISA allowance is the maximum amount that can be paid into tax-advantaged ISA wrappers in a tax year. In 2021/2022 annual allowance for an ISA is £20,000. Investments within an ISA are protected from UK tax, which means that they can produce income or grow in value without producing a tax bill.

A Stocks and Shares ISA can be a key component of a financial plan and is commonly funded by a lump sum payment or by regular payments. It is also possible to consolidate previous tax years’ ISAs into a single ISA. Investors add funds to the ISA to get the tax advantages, whilst maintaining the ability to access the funds when they need them.

The ISA annual allowance cannot be carried forward to future years and resets on the 6th April each year.

2. The Pension Annual Allowance

The pension annual allowance is the maximum amount you can contribute in total to your pensions in the tax year without suffering a tax charge. Personal contributions will benefit from tax relief as long as they don’t exceed your UK relevant earnings in the year. In 2021/2022 the annual allowance is £40,000, but this amount is reduced for the highest earners or for people who have flexibly accessed their pension. Investments within a pension are sheltered from UK tax, similar to an ISA, but are subject to UK tax on withdrawal apart from the tax free cash element.

A pension is the foundation of retirement planning and is usually funded by regular payments. Investors add funds to the pension to build retirement funds and obtain the tax advantages but cannot access the funds again until normal retirement age. The normal retirement age is currently 55 but is increasing to 57 in April 2028.

The pension annual allowance can be carried forward for up to three tax years if eligible, and replenishes on the 6th April year, meaning there is ample opportunity to designate funds for your retirement.

3. The Dividend Allowance

The dividend allowance is the amount of dividend income an individual can earn during the tax year before income tax is payable. In 2021/2022 the dividend annual allowance is £2,000. Dividend income arises most commonly from the direct ownership of shares in a company or via a collective investment, such as a unit trust, and is often used to supplement income from employment or other savings. Dividends within ISAs and pensions are not taxable and do not count towards the allowance.

The ownership of shares as part of a diversified portfolio allows investors to receive dividend income and use the dividend allowance. Furthermore, the value of the shares can also increase over time, allowing the investor to use the next allowance – the capital gains annual exempt amount.

The dividend allowance cannot be carried forward to future years and resets on 6th April each year.

4. The Capital Gains Annual Exempt Amount

The annual exempt amount is the amount of net capital gains an individual can make during the tax year before capital gains tax is payable. In 2021/2022 the annual exempt amount is £12,300. Capital gains can arise from the sale of a variety of assets, including shares and property. Capital gains within ISAs and pensions do not count towards the allowance.

The ownership of shares and property allows investors to benefit from the potential increases in the value of the asset. If the value of the gain is within the annual exempt amount, there is no tax to pay on sale. Particularly for shares, which can be sold one at a time or in tranches, there is an opportunity to sell the right amount each year to use the annual exempt amount.

The annual exempt amount cannot be carried forward to future years and resets on 6th April each year.

5. The Inheritance Tax Annual Gift Exemption

The annual gift exemption is one of the ways of making gifts that are classed as being immediately out of the donor’s estate for inheritance tax purposes. In 2021/2022 the annual gift exemption is £3,000 and there are a variety of ways the gift can be made. Gifting can be a key component of inheritance tax planning and the £3,000 annual gift exemption is useful for people who wish to reduce the inheritance tax.

The annual gift exemption can be carried forward for up to one tax year as long as the current tax year exemption is also being fully used that year, and resets on the 6th April each year.

Summary

There are a variety of annual allowances and exemptions available to individuals in the UK which can be used to place money in tax-advantaged wrappers or mitigate a liability to income tax, capital gains tax or inheritance tax. Most annual allowances are lost at the end of the tax year, so it is important to identify if there is a prudent way to utilise the available allowances.

If you would like to discuss any of the allowances in this article, or investment planning and tax planning more generally, please feel free to contact us on 01903 534587.

* The value of investments can increase or decrease so you may get back less than you invested

+ The Financial Conduct Authority does not regulate tax advice