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The Government is keen to take our hard-earned money and has plenty of plans for spending it – but so do we. In my view, there is absolutely nothing wrong with utilising straightforward measures to reduce your tax bill.
Usually in my weekly column I answer your (always very good) tax questions. But this week, to mark the relaunch of Telegraph Money, I wanted to give you six easy tax-cutting tips to take away with you.
Consider Bob, his wife Sally and their three children. Bob runs his own company in which Sally has some shares. He is a higher-rate, 40pc taxpayer. They have a £200,000 mortgage which recently moved to a variable interest rate of 7.5pc which Bob would ideally like to pay off.
Bob has owned an investment property for 10 years which he bought for £200,000 using a £150,000 mortgage on which he is paying a mortgage at 8.5pc. He has some listed shares that are currently in profit that he would like to keep.
Ten years ago he invested in a “single premium” insurance policy which he has not drawn on but which he would now like to realise. It is worth £50,000 and is currently showing a profit of £15,000. Sally is not currently working while she brings up the children. She also helps to care for Mavis, her elderly widowed mother.
So, what choices does this family have to improve their tax position?
1. Use ‘bed and spouse’
The annual capital gains tax allowance is currently £6,000 but falls to just £3,000 from next April. Bob’s shares are showing a profit and it could make sense to take full advantage of the allowance this year. Ideally he would like to sell shares and buy them back again to raise the CGT “base cost” against future disposals.
Unfortunately the so-called “bed and breakfast” rule prevents this working if you buy the shares back again within 30 days. However, there is nothing to stop Bob selling shares and Sally buying shares in the same company on the same day as long as it is done through the stock market rather than directly between them.
This is sometimes called “bed and spousing”. The potential saving for Bob when he sells the shares would be £1,200 (£6,000 capital gains tax at 20pc).
2. Get £720 of free pension... even if you don’t have any income
Making pension contributions from your earnings is well understood, but what can Sally do when she is not currently employed? Fortunately she can still save towards a pension and obtain tax relief despite not being a taxpayer.
She can make contributions to a pension fund of up to £2,880 each year and the fund can claim a further 25pc of this amount from HMRC. She is effectively obtaining basic-rate, 20pc, income tax relief on a gross contribution of £3,600 and so saves £720.
3. Transfer an insurance policy and cash it in
If Bob cashes in his whole insurance policy, the profit of £15,000 will be caught for income tax at around 20pc. He can save tax in two ways. If he cashed in just half of his original investment in the right way, no tax would be due currently. This is because up to 5pc of the investment can be withdrawn and treated as a part of the original capital invested (see box below for more detail).
Alternatively, he could realise the whole investment for the family tax free by simply assigning the policy to Sally for her to cash it in. Under some complicated “top slicing” rules the profit (£15,000) is divided by the length of the policy (10 years) and because that amount added to her income does not take her into higher tax rates, no further tax is due. This arrangement would therefore save the family £3,000.
4. Save hundreds... by borrowing
Bob’s buy-to-let property is now worth £300,000 and his bank are prepared to increase his property loan by £50,000. Interest on rental properties no longer qualifies as a deductible expense, but a tax credit is given at a rate of 20pc on the interest paid.
If he takes up the offer from the bank to take his property borrowing up to £200,000, interest on the whole balance should qualify for the 20pc basic-rate credit. This is because the amount of the loan will not exceed the value of the property when he started letting it.
The HMRC manuals explain that he could subsequently withdraw £50,000 of surplus capital from his letting business and use it to pay off part of his mortgage. The overall saving from this would be about £350 a year.
5. Incorporate – and offset mortgage interest
The shares Sally owns in the company are worth about £100,000. Bob has a supportive bank which would be prepared to lend him £100,000 to buy the shares from Sally at a favourable interest rate if they are able to take a first charge on their home.
The current mortgage is £200,000 but this could be reduced by £50,000 from the redemption of Bob’s insurance bond and another £50,000 extracted from his buy-to-let property business. Together they would have sufficient money to pay off the current mortgage.
Bob will pay £500 in stamp duty but, as a loan to buy shares in a qualifying company, his loan interest will qualify for income tax relief at 40pc. It could give an annual saving of around £3,000.
6. Make full use of your pension
When her husband died, Mavis inherited the family home, now worth £400,000 and she became the beneficiary of his self-invested personal pension, or Sipp, now worth £200,000. She also has investments worth £150,000.
Like many people, she worries that inheritance tax will be payable on her death. Fortunately she should be able to avoid this. Apart from the standard nil-rate band of £325,000 she will have the £175,000 residence nil-rate band, or “family home allowance”, available.
Structured correctly, the balance in her Sipp can pass free of inheritance tax to provide pension benefits for her children. The remaining £150,000 can be avoided because her executors will be able to claim her husband’s unused nil-rate band and, if necessary, his unused residence nil-rate band. So even with the £325,000 allowance frozen since 2009 she should not have to worry about this most unpopular of taxes.
Next week I’ll be back to my usual column. As always do email me – I read them all – and your answer could appear in a future column: taxhacks@telegraph.co.uk
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