A largely cautious Budget caused enough anger to precipitate a U-turn but, now the dust has settled, certain details stand out.
The last ever Spring Budget was supposed to be proof of the government’s prudence and tenacity ahead of Brexit negotiations. The chancellor not only chose to ring-fence the surplus funds partly generated from better than expected economic performance, thereby creating an unofficial Brexit back-up fund, but also kept changes to a minimum – and, aside from confirmation that the money purchase annual allowance changes were going ahead, we were once again spared fundamental changes to pensions tax relief. Instead, he highlighted buoyant growth and jobs figures, jovially landed a few blows on Labour, and received almost none in return.
Yet any government satisfaction over a job well done quickly dissipated as opposition to the chancellor’s planned rise in National Insurance contributions (NICs) for the self-employed received sustained attacks from the Tory backbenches and right-leaning media outlets. On Wednesday, the government decided to cancel its NICs plan, bringing humiliating closure to a week of fallout.
The decision to back away from NICs reform inevitably left the Budget looking even emptier than before. Nevertheless, it would be a mistake to ignore the chancellor’s announcements completely, some of which could have a significant impact on those seeking to save and invest tax-efficiently. Perhaps chief among the changes was a reduction in the tax-free Dividend Allowance, which will fall from £5,000 to £2,000 from 2018-19.
The reduction in the Dividend Allowance, and the increase in NICs, were a combined attempt by the Chancellor to reduce what he saw as a tax imbalance between so-called “owner managers” of private companies, the employed and self-employed. A wider review of employment practices in the UK has been launched so it won’t be the last we hear of this. The reduction of the dividend allowance will also have an impact on individual investors, such as those holding shares and unit trusts. According to Tony Wickenden, Executive Director at St. James’s Place, the freedom from national insurance enjoyed by dividends and the continued availability of a tax free dividend allowance mean that dividends remain a key part of effective financial planning for business owners and investors.
“Even when the tax-free Dividend Allowance reduces to £2,000 in 2018/9, the fact that dividends don’t bear National Insurance means that they remain the most financially effective way for an owner /manager of a company to withdraw profit that isn’t needed in the company and isn’t to be contributed to a pension,” says Wickenden. “Extraction by way of dividend rather than pure salary remains the best way to minimise outflows from your business to the Treasury. When you factor in the low Corporation Tax rate we already have, the dividend route looks all the more appealing. Of course, each case will be different and the value of informed advice in deciding on the right profit extraction strategy remain essential”
When it comes to individual investors, Wickenden argues that the “tax-advantaged homes of choice” remain ISAs and pensions. Once contribution capacity to those is maximised though, he points out that the Dividend Allowance (effectively a nil tax band) provides a very useful further opportunity for tax savings – despite the Chancellor turning the screw. Under the current allowance, on a dividend yield of 3% you could be looking at an investment of over £160,000 per individual that is free of tax on income and in respect of capital gains there’s the Capital Gains Tax exemption of £11,300 from next year.
“When the Dividend Allowance drops to £2,000, just on pure maths, you’re looking at tax-free yield from more like £60,000 [as total investment and based on a 3% yield], but that’s per individual, so for a couple it would be £120,000 on top of their ISA and pension,” he says. “All this talk of tax and tax freedom just reminds us of the need to take advice in order to optimise your tax-advantaged allowances.”
The end of the tax year falls in less than three weeks, meaning that time is now running out to take advantage of this year’s allowances, from ISAs to pensions; opportunities made even more important by last week’s announcement on dividend taxation. But the new tax year will bring its benefits too, including a healthy increase in the ISA allowance to £20,000. As the risk of inflation looms, investors would be wise to use whatever opportunities they can to protect and grow their capital tax-effectively.
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