Tax allowances shrink 6% in a decade as fiscal ice age continues

30 March 2022

Plan now to make use of the available allowances this coming tax year

Calculations from Quilter, the financial adviser and investment platform, reveals that government tax breaks for savings and investments have become less generous in the past decade, decreasing by an average of 6%.

Quilter has analysed eight main UK tax allowances, of which six have either frozen or decreased, including vastly less generous pension allowances and frozen inheritance tax thresholds.

The pensions annual allowance, the limit on how much money you can build up tax-free in your pension in any one tax year while still benefiting from tax relief, has shrunk by 20%, while the equivalent lifetime allowance has dropped by 28%. Pension savers have also been hampered by a 60% reduction in the money purchase annual allowance.

The nil rate band for inheritance tax – the threshold above which inheritance tax is payable – has remained frozen since 2009. Conversely, house prices have rocketed by 9.6% in just one year to January 2022, reaching an average of £274,000. Office of Budget Responsibility projections reveal this ‘fiscal drag’ effect, which is pulling more owners of modest homes into the IHT net, will eventually boost government coffers by £8.3bn by 2026/27, a 63% increase in inheritance tax revenues from 2019/20.

Source: Office of Budget Responsibility, March 2022

Meanwhile, the annual inheritance tax gifting exemption has not altered in years, remaining at £3,000 since 1981, which if indexed would be £12,253 today. If indexed the nil rate band would stand at £464,512 today and instead remains frozen at £325,000 until 2026.

1. Dividend allowance was introduced in the 2016/17 tax year
2. Money Purchase Annual Allowance was introduced in the 2015/16 tax year

Shaun Moore, tax and financial planning expert at Quilter:

“The various tax allowances and thresholds are great ways to incentivise people to save for their future and distribute their wealth. However, many of these have taken huge hits over the past decade and face a big freeze in the years to come.

“In the Spring Statement the Chancellor was clear with his intentions to balance the books to help pay for the pandemic response, so despite the reductions you could argue that these allowances and thresholds are not going to be as good for a long time to come. As such, it will be vital for individuals to utilise their tax allowances as much as they can this coming tax-year and take advantage of the situation today.

“It is also worth remembering that many of these allowances have failed to keep up with inflation, which has risen by 26%* over the decade and continues to rachet up each month, effectively decreasing the allowances in real terms over time. Putting cash to work in a pension could help to beat inflation through investment growth and tax relief, while gifting to a family member now could make a real difference to them against the backdrop of the cost-of-living crisis and may help to reduce your IHT liability.

“The new tax-year presents no better time to plan for efficient use of allowances for the tax-year ahead. If you are unsure about where to start, a financial adviser can help you identify how to make better use of the tax allowances available to you.”

*Bank of England inflation calculator, 2012-2021.

Shaun Moore offers the following tips to make better use of tax allowances:

Bed & ISA

“Doing a bed & ISA can be a great way to bring assets within the tax shelter an ISA can provide. It is effectively bringing cash often from the sale of existing investments from outside of an ISA and buying the same holdings within an ISA.”

CGT headaches

“The latest data shows that £30.1bn was paid in capital gains tax in the last three years and this figure is rising. CGT is meant to be a tax for the wealthy but more and more of the middle classes are getting caught by it. An investment account with just £61,500 that returns 20% will see returns equal to the CGT exemption of £12,300. An £82,000 portfolio with returns of 15% would result in the same situation. By realising gains and making use of your allowance you are not allowing the problem to be kicked down the road. Staying invested is vitally important over the long-term but speaking to a financial adviser can help you mitigate some of the issues that can arise from rising asset prices, especially as this is a complicated area.

Family planning

“ISAs provide a very generous £20,000 allowance. While many won’t get near this, there are some who will max out their ISA and have excess cash to use. Thanks to the £9,000 Junior ISA allowance, a couple with two kids effectively have a tax free savings allowance of £58,000. In a more extreme example, a couple with six grandchildren can shield £94,000 in ISAs each year. This can bring about significant investment returns for the next generations and given the money is locked up until they are 18, it also reduces the concerns that come with gifting money to children.”

Flexi-ISA

“Not all ISAs are flexi-ISAs so it is important to see if yours is. These ISAs effectively mean that you can withdraw money from your ISA and pay it back within the same tax year without affecting your annual ISA allowance. Therefore, if you know you need to make a withdrawal but want your allowance protected, you should be ensuring your ISA is a flexi-ISA.”

Spousal exemption

“This can be a really powerful tool to help share the tax burden amongst a couple. If you are expected to exceed the capital gains tax exemption, then you may wish to transfer the asset to a spouse so they can use their own exemption to realise the gain and prevent you from paying CGT unnecessarily. The other thing you can do is transfer the asset into joint ownership, effectively boosting your CGT exemption from £12,300 to £24,600. Clearly if you both have gains to realise then you will need to manage these appropriately but using spousal exemptions can help mitigate some of the issues selling an asset can incur.”

Invest early in the tax year

“Rather than leaving top-ups and contributions to the last minute, you will want to consider investing as early as possible in the tax year in order to maximise time in the market. 2021 was a good year for markets but many will have missed out on these returns as they instead waited until the end of the tax year to get their financial affairs in order. Going forward, don’t be late as it can have significant impacts.”