Annual tax allowances: lose them or store them

One of the big things we can all do with our money is to maximise how tax-efficient it is.

In other words, pay less tax.

You know that feeling when you get a new job or a pay rise thinking you’ve hit the jackpot, only to realise a decent chunk of that goes straight to the taxman.

When I talk about tax-efficiency, I’m referring to the various tax rules you can use to your advantage to keep more of your money in your pocket.

An annual tax allowance is something you’re entitled to every tax year to help shelter your money from tax deductions. I’m not talking about dodgy accounts in banks on Caribbean islands. This is all above board.

A unique feature of an annual tax allowance is how long it lasts for. Some have to be used that year or are lost for good. Others have more flexibility and can be kept for longer.

Here are some common annual tax allowances to think about as the end of the tax year approaches in April.

Adult Annual ISA Allowance: £20,000

Every tax year, adults aged at least 18 can put up to £20,000 into an ISA and any growth and withdrawals on that £20,000 is tax free.

There are four types of ISA:

Cash ISA – like a savings account (minimum age is actually 16 for this ISA)
Stocks and Shares ISA – an investment account
Lifetime ISA – specifically for buying a property or saving for retirement
Innovative Finance ISA – peer-to-peer investment account (unlikely you’ll use this!)

It’s one of the most generous tax allowances in the world and is attractive because of the new allowance you get every year.

That said, if you don’t use it, you lose it.

So, the maximum allowance for an ISA in any tax year is £20,000. There are rules on inheriting an ISA allowance if your spouse dies, but that’s for another time.

So make the most of every tax year when it comes to your ISA, however much or little you want to put into it.

Junior Annual ISA Allowance: £9,000

A Junior ISA is effectively the same as an Adult ISA, but it’s for a child under 18.

There are two types of Junior ISA:

Cash ISA
Stocks and Shares ISA

A Junior ISA is held in the name of the child, with a parent that manages the account until the child takes control of the account at 16, and can withdraw money aged 18.

Just like an Adult ISA, if you don’t lose up your annual allowance, you lose it.

Junior ISAs can be popular with wealthy families that may want to provide future tax-free income for their children.

A family of two adults and two children under 16 could have a total Adult and Junior ISA allowance of £58,000 (2 x £20,000 and 2 x £9,000).

And if your wealthy children have been well financially educated, when they turn 16 they get a very generous allowance of £29,000 per tax year. This is because they can put money in an Adult Cash ISA (£20,000) and still contribute to their Junior ISA too. Then aged 18, they are only eligible for the Adult ISA allowance.

Capital Gains Annual Allowance: £12,300

A capital gain is a profit you make on something you own.

You take the price you paid for it and price you sold it for. Any increase is the gain and could be subject to tax in the UK.

The most common forms of a capital gain in the UK come from:

Stocks and Shares
Property that isn’t your main residence

The Capital Gains Annual allowance means that every tax year, you can make £12,300 worth of gains and not pay tax on it.

Anything over that then becomes subject to capital gains tax. And the tax rate depends on your other income and earnings.

If you don’t lose it, you lose it.

Some people on track to make big gains over £12,300 may choose to sell some of their ‘things’ (known as assets)’ to make use of the annual allowance. This strategy may not always be the best option so is worth getting professional advice.

With a capital gains tax allowance, just because you’ll lose it doesn’t automatically mean it makes sense to use it.

Dividend Allowance: £2,000

A dividend is like a reward for your loyalty.

They are commonly given to people who buy shares in a company.

When the company does well, it rewards its shareholders with a dividend.

Anybody can be a shareholder. You don’t have to be sat in a suit in a fancy office.

As long you earn less than £2,000 a year in dividends, which the average shareholder is unlikely to exceed, you’ll pay no tax on your dividends. It can be a nice little income boost knowing all of it is going straight in your pocket.

If you don’t use it, you lose it. Unfortunately, if the companies you’re a shareholder of don’t have a great year, there’s not much you can do.

Like capital gains tax, if you make more than £2,000 a year in dividends, anything over £2,000 is then subject to tax, factoring in your other income and earnings.

Annual Gift Allowance: £3,000

This allowance is specifically related to inheritance tax. And it’s really for people with very large estates that could be subject to inheritance tax when they pass away.

This gift allowance means that every tax year, you can gift up to £3,000 (in one gift or multiple gifts) and that £3,000 is immediately removed from your estate for the purposes of future inheritance tax calculations.

If your estate is liable to inheritance tax, a £3,000 gift could immediately save 40% tax on £3,000.

This annual allowance can be stored until the next tax year.

So if you don’t gift £3,000 in the 2021/22 tax year, that gives you £6,000 to use in the 2022/23 tax year.

Pension annual contribution allowance: up to £40,000

Whether you have a workplace pension, or pay into your own self-managed pension, everybody has an annual allowance in terms of the amount they can put into a pension each tax year and get tax relief.

It is either £40,000 or your annual salary, whichever is the lower.

I should add, you can contribute more if you earn over £40,000, but you essentially won’t get the tax benefits on anything over £40,000.

Annual pension contributions have a special rule called carry forward.

This means that if you don’t use all your annual allowance, you can roll it over for up to three tax years.

Let’s use an example:

Tom earns £70,000 a year so his annual pension contribution allowance is £40,000 for the purposes of tax benefits.

In the previous tax year, he only contributed £10,000 to his pension. That’s £30,000 unused from his allowance.

That £30,000 then rolls over for up to three tax years. So let’s say next year he comes into a lump sum of money.

He could use £30,000 + £40,000 = £70,000 should he want to make a large pension contribution.

Once three tax years pass, that £30,000 unused allowance will be lost forever.

When using carry forward, note that the maximum you can contribute in a tax year for tax relief is your maximum earnings.

So if Tom had carried forward + annual allowance of more than £70,000, he would have to save some of it for the following tax year.

Summary

When it comes to your finances, start thinking about your money in terms of tax years. And then think about the tax allowances you could use to make your money more tax efficient.

Just remember, with a tax allowance comes a time window. So, make sure you know how long you have to use it!

For more on managing your finances, check out A Money Thing Happened, run by Jordan who works in Financial Advice.