Since the Autumn Statement was delivered on 17 November, pensions and individual savings accounts (ISAs) have become more important than ever before. The economy’s in crisis, inflation‘s soaring, households face rising energy costs, bills and interest rates. The latest Chancellor, Jeremy Hunt, has had to make tough choices.
Freezing tax thresholds, cutting tax allowances and even increasing Child Benefit in line with inflation all make pension payments more attractive, if you’re lucky enough to have the spare money to invest. Read on to find out how paying more into pensions and ISAs could help you reduce the amount of tax you pay.
Protection from dividend tax and capital gains tax
The Chancellor announced cuts to the amount of dividends and capital gains people can earn before they start paying tax. Capital gains are the profits earned from selling assets that have gone up in value, such as shares, a second home or artwork. While dividends are profits paid out by limited companies to their shareholders.
The capital gains tax (CGT) allowance will be cut from £12,300 to £6,000 in the tax year 2023/24. It’ll take another cut in 2024/25 when it drops down to £3,000. Similarly, the dividend allowance will be reduced from £2,000 to £1,000 from the tax year 2023/24, and it’ll be further reduced to just £500 from the tax year 2024/25.
If you want to escape tax on gains and dividends, you could consider taking advantage of pensions and ISAs rather than investing via general accounts. Pensions and ISAs have the superpower that means any investments inside them are able to grow untouched by the tax man, so you can hang onto more of your own money.
More people will be able to get higher tax relief on pensions
The Chancellor extended the freeze on the amount that can be earned before paying 20% basic rate tax, known as the ‘Personal Allowance’, so that it will be stuck at £12,570 per year until the tax year 2028/29. Similarly, the threshold when 40% higher rate tax kicks in will also be frozen at £50,270 a year until the tax year 2028/29.
Rather than scrapping the 45% additional rate income tax altogether, as previous Chancellor Kwasi Kwarteng proposed, Jeremy Hunt’s actually making more people pay it, by reducing the threshold from £150,000 to £125,140 a year from the tax year 2023/24.
Freezing thresholds is a way of ensuring people face higher tax bills in the future, as wage rises push millions over the thresholds. By 2027/28, an extra 1.6 million people are likely to be paying income tax, up from 34 million to 35.6 million, according to forecasts by the Institute for Fiscal Studies. The number of higher or additional rate taxpayers is also expected to shoot up by 1.7 million.
The silver lining of landing in a higher income tax bracket is that you’ll then get higher tax relief on your pension contributions. To encourage people to save for retirement, the government adds tax relief to pension payments, based on your highest income tax rate.
Most basic rate UK taxpayers automatically get a 25% tax top up on their pension contributions, but eligible higher and additional rate taxpayers can also claim an extra 25% and 31% tax top up via Self-Assessment. Even those pushed into paying income tax for the first time will potentially be able to pay more into their pensions and nab extra tax relief. Non-taxpayers can put a maximum of £3,600 a year, including tax relief, into a pension. But once you start paying basic rate income tax, most people are allowed to stash away up to 100% of earnings, to a maximum of £40,000 a year.
Protection from inheritance tax
Pensions could also save you money on Inheritance Tax (IHT), as the Chancellor also froze the IHT thresholds until the tax year 2028/29. Few families actually pay IHT, but when they do, the 40% tax hits hard. In the tax year 2019/20, only 4% of deaths resulted in an IHT bill, but the average bill topped £216,000, according to the Office for National Statistics (ONS).
Inheritance Tax is charged if your ‘estate’ – that’s the value of your property, money and belongings at your death – is worth more than £325,000, after debts are settled. There’s also a £175,000 ‘residence nil rate band’, which applies when leaving your home to your children or grandchildren. Anything that married couples or civil partners leave to each other, up to £1 million, passes free from IHT.
While the thresholds are frozen, rising house prices and inflation will push more families into paying IHT, with potentially bigger bills. However, any money left in your pension fund when you die passes to your nearest and dearest without IHT, so long as you’ve named them as beneficiaries. So topping up your pension pot is one way to avoid paying extra tax.
Hang onto more generous Child Benefit
The Chancellor announced that the State Pension and assorted benefits, including Child Benefit, will be increased in line with inflation at 10.1% from the tax year 2023/24. This means a family with two children will see their weekly payments go up from £36.25 to £39.90.
Child Benefit is withdrawn for higher earners, by 1% for every £100 in income over £50,000 a year brought in by the highest earner in the household. However, you can deduct pension contributions from your income before calculating the High Income Child Benefit Tax Charge. If paying more into your pension brings your income below £60,000 a year, you can hang onto more of this increased Child Benefit, and if it dips below £50,000 a year, you’ll be able to keep the full whack.
Warning signs about State Pension age
Currently, those that are eligible for the State Pension can claim from the age of 66 (rising to 67 in 2028). The review‘s due to consider whether the rules around pensionable age are appropriate, based on the latest life expectancy data and other evidence, and whether the increase to age 68 should be brought forward.
If you don’t fancy staggering on at work until your late 60s, stashing extra cash in pensions and ISAs can bring the freedom to retire earlier. Right now, you can get your hands on private and workplace pension money as early as 55 (rising to 57 in 2028), while money from your ISA can be withdrawn at any time.
Thanks to the Autumn Statement, paying more into your pension can help you:
Stay within the new thresholds for capital gains and dividends, when their tax-free allowances are cut in the tax years 2023/24 and 2024/25.
Nab extra free money in tax relief, as thresholds frozen until 2028 will push more people into paying income tax, and more into paying higher rates.
Save money on Inheritance Tax, with IHT-free thresholds also frozen until 2028.
Hang on to Child Benefit, which is going up by 10.1% in the tax year 2023/24.
Faith Archer is a Personal Finance Journalist and Money Blogger at Much More With Less.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.