Budget update and tax year end planning
Join Justin Corliss and Fiona Hanrahan as they explore key changes announced in the October 2024 Budget.
They will discuss the upcoming employer National Insurance increase and the advantages of salary exchange. Additionally, they will discuss the proposal to apply Inheritance Tax to pensions starting April 2027, and what client conversations you should be having now.
The concept of carry forward, using pension contributions to mitigate capital gains tax charges, and how pension contributions can help you avoid tax traps will be covered.
Learning objectives:
By the end of this session, you’ll be able to:
- Outline the changes to taxation announced in the October 2024 Budget
- Describe tax traps and how to avoid them using pensions
- Explain intergenerational tax planning opportunities
- Demonstrate how pensions can help with the taxation of other wrappers.
View transcript
Hi everyone. My name is Justin Corliss. I'm joined today by my colleague Fiona Hanrahan. We're both part of the technical marketing team here at Royal London and thank you very much for joining us on this first webinar of 2025. Now, today, we're speaking about updates from the budget on 30th of October 2024 and of course, about the upcoming tax year end.
So, there's quite a lot for us to discuss, but much of it reconfirms that a pension isn't just good for the future, but also good for the present. Now, pensions might not always seem like the obvious answer to some of the financial issues that we'll discuss, but using them can solve tax issues, solve or retirement income need, and solve intergenerational issues as well.
All good bread and butter planning angles. Now of course, for this to be CPD-able, we need to have some learning objectives. So, our learning objectives today are that by the end of this session, you'll be able to outline the changes to taxation announced in the October 2024 budget, describe tax traps and how to avoid them using pensions, explain intergenerational tax planning opportunities and demonstrate how pensions can help with the capital gains tax charge. Now the learning objectives are often pretty high level, aren't they? So, I'm just going to outline what we're going to cover in a little bit more detail. We'll talk about the employer National insurance increase coming in April 2025 and how salary exchange could become even more important.
We'll talk about the most common tax traps and how a pension contribution can help get out of those. This is important to consider before the end of tax year, or the tax year end, rather. I t's always a common topic at this time of year but will cover off the most important aspects of carry forward. We'll go over how pension contributions can help reduce a capital gains tax charge, before tax year end once again.
And finally, we'll talk about what we do know about the proposal to apply IHT, or inheritance tax to pension death benefits, from April 2027. This is a topic I think we'll be talking about quite a lot in 2025 and in 2026 as well. Okay, so let's get into the key points emerging from the budget on the 30th of October 2024.
Now, as you can see from our first point there, and I assume you're all very aware of it anyway as it affects your business owner clients and in many instances you yourselves, as in as you'll be employers, the employer National Insurance rate will increase from 13.8 to 15%. Now, in addition, the threshold at which employers need to begin paying employers National Insurance contributions will decrease from the current point of £9,100 to £5000.
Now, all other things being equal, these changes would see employers paying an additional National Insurance contribution for someone on £35,000 a year, which is roughly the national average for an adult person in the UK. So, an additional national Insurance contribution for that person of £925.80 per annum. Now, as you can see at the bottom of the screen, this charge takes effect, or this change, beg your pardon, takes effect from the 6th of April 2025. So, I guess that's the bad news. There is one potentially positive outcome around salary exchange, which we will look at shortly, but overall, I doubt many employers will have welcomed this change. On a slightly brighter note, though, we need to be aware of the change to the employment allowance.
Now that's the proportion of an employer's national Insurance bill that the employer doesn't have to pay now prior to October 2024 budget. This was only available to an employer whose total National Insurance bill for the year would fall below £100,000, and if this was the case, they wouldn't have to pay the first £5,000 of the National Insurance bill that they would otherwise have been liable for.
The budget changed this, though. From the 6th of April 2025, the employment allowance will increase from £5000 to £10,500, and perhaps just as significantly, it will be available to all eligible employers. So that means that it will now be available to employers with a National Insurance bill over £100,000. The upshot of this is that some employers will pay less National Insurance from the 6th of April 2025, some will see their costs unchanged, and some will see an increase in their employer National Insurance costs. It would appear that the winners here will be those firms whose National Insurance bill had previously been just over the £100,000 mark, meaning that they go from missing out on the £5,000 employer allowance by a relatively small margin to being eligible for a £10,500 allowance, which will offset some of the headline rate increase for National Insurance.
The other obvious winners are smaller businesses who perhaps previously had a national insurance bill between £5000 and £10,500. They are likely to see a saving as they will now fall within the employment allowance and have no employer National Insurance to pay. Okay, what I'd like to do now, though, is to run through a quick case study of an employer introducing salary exchange, just to illustrate how employers can use that to mitigate some of the impact of the National Insurance rate increase.
Okay. So, let's take a look at the salary exchange example. Now, from my experience, salary exchange is somewhat misunderstood in that it's more of a National Insurance saving than it is tax saving. And given that, you know, really quite relevant to an increase in employer National Insurance rates. Now, one potential benefit, or very least something that we can turn to the advantage of employers is using salary exchange for pension contributions.
Now, virtually all employers are required to operate a workplace pension scheme and while many use salary exchange when doing this, the majority don't. However, the salary exchange is likely to be much more appealing following the increase in employer National Insurance from April this year. Now, in the lead up to the budget in October 2024, there was a lot of speculation that employer National Insurance would be levied on employer pension contributions.
But as we know now, that didn't happen. Instead, the overall rate of employer National Insurance increased by 1.2%. But as employer pension contributions are still not liable to employer National Insurance, it's important to remember that when pension contributions are made via salary exchange, all the pension contribution is an employer contribution, and that could be turned to the advantage of both employers and their employees.
We may see savvy employers altering their approach to salary negotiation with employers and perhaps having a greater focus on the overall remuneration package, rather than such a heavy focus on headline salary alone. Anyway, let's have a quick look at the case study to bring this, to life a little bit. So here we have Sam, who works for Royal London Sockets Limited and has a pensionable salary of £35,000 per annum, which is roughly the average salary for UK adult.
Now his automatic enrolment scheme sees him contribute 5% of pensionable salary and his employer 3%. So, we're assuming there are no band earnings here. So, 8% is paid from pound one. Royal London Sockets Limited, Sam's employer, have approached you to review their workplace pension scheme for their 100 employees. They don't currently utilise salary exchange. Okay, so, what we're going to do is to look at Sam's position pre and post salary exchange.
Then at the employer's position pre and post and then at the overall. Now just before we start, I just want to say don't get too hung up on the maths and the numbers at this stage. Rather focus on what we're trying to achieve. So, if we look first of all at Sam okay. Before salary exchange, you can see there along the top row, certainly the top row that has numbers in it, he's got, a headline salary of £35,000.
He makes his own pension contribution of £1,750 gross, 1400 net as you can see on the, on the second last row. And he has a take home salary of £27,320. Moving across to the right-hand side after salary exchange, he said line salary is lower. He makes no pension contribution as his employer now makes all of this on his behalf, and his take home salary is still £27,320.
So, while it's lovely that Sam's take home salary hasn't changed, we haven't seen any real benefit to him thus far. Okay, to see this, we need to look at the employer's position now. By the employer paying Sam less salary, Sam makes a national insurance saving. And so does the employer. Now, in our example, Sam is redirecting all of his National Insurance savings to his pension, and the employer is redirecting half of their National Insurance, saving to Sam's pension and keeping the other half of themselves, which they quite entitled to do.
The employer could keep all of their national insurance savings, and there are a few other options too. So, if you want more information on that, you know, have a word with your usual Royal London business development manager. But in our example, Sam is redirecting all of his National Insurance savings to his pension. The employer is redirecting half of their savings to Sam's pension, keeping the other half for themselves.
So, we know that Sam's headline salary is going down but look at the employer pension contribution row. The employer's pension contribution has gone from £1,050 per annum before salary exchange to £3,129 per annum after salary exchange. And this is because they still pay their £1,050 contribution, plus all of Sam's contribution, plus all of Sam's National Insurance saving, plus half of the employer's National Insurance saving all into Sam's pension.
And even with all this additional pension contribution that the employer is making, the cost of employing Sam reduced by £134 per annum. So, Sam now has £3,129 per annum going into his pension, which is £329 extra each year for the same take home pay he received when making a pension contribution without using salary exchange. And that's a really key point.
It doesn't make your pension contribution free; you just get more bang for your buck. Royal London Sockets Limited Total cost of employing Sam for the year reduces by £134. As I mentioned earlier, if we had 100 Sam's in the scheme and we could very easily have that, which is kind of why we put him on the national average salary.
Okay. So that we could feasibly have 100 Sam's in the scheme. That would mean a saving every year for the employer of £13,400. Now, I'd argue that, you know, you, as the adviser, have gone a good way to creating your own fee there. Plus, perhaps enough to pay for some sort of, you know, business protection or other sort of benefit, and perhaps the solicitor's cost to set up the salary exchange contract in the first place.
And you know what? I'd really hammer that home with the employer might be something like in the first year, you know, this is going to be, my fee for doing the switch of the scheme or the transfer of the scheme and so on. And then on an ongoing basis, I'll charge X proportion of this saving as my ongoing retainer.
And just to ensure that the employer is aware that when it comes time to pay your fee, you know, next year and the year after, the year after and the year after that, that this is not a cost to them. This is money that they wouldn't have had if you hadn't created this saving by implementing salary exchange in the first place.
Now they the employer would clearly also have, you know, ongoing protection costs in in future years, if that's what they set up. But any sort of solicitor's fee for the change of contract of employment would likely be a one-off payment. So less likely that that's going to be an ongoing cost for them. Okay. Salary exchange won't be suitable for absolutely everyone though, and there are a few pitfalls that, you know, you should be aware of and make employees and employers are aware of. Things like, you know, it could reach it will reduce the headline a salary so it could potentially impact death-in-service lump sums. I know there are instances where, firms do, you know, keep a headline rate of salary to base that death in service lump sum on.
But that would need to be discussed. It could impact the employee's borrowing ability. Once again, more and more lenders actually look at net income rather than, gross headline salary. So that might not be the case. But these are things we need to be aware of. And you need to be careful not to reduce anyone's salary below the national living wage or below the level to be an eligible job holder.
And as I sort of alluded to already, it is a change of contract of employment. So, it is likely that you're going to need to get legal advice if making that change. But, you know, provided that these points can be addressed and there are savings, you know, to be made that can help to address them. Using salary exchange can be highly advantageous for both the employer and for the workforce.
Right. So, we've sort of explained the benefits of, salary exchange and, highlighted earlier the increase in employer National Insurance contributions, which will, you know, come into effect from the 6th of April this year. But let's have a look at the impact for Royal London Sockets Limited. Now, you'll remember that they have 100 employees and we're assuming an average salary of £35,000.
Okay. Now if we now look at the employer National Insurance row okay. The National Insurance is rising from £3,574. That's the figure in brackets. That's the current figure to £4,500 per employee here, with effect from the 6th of April, you know, before salary exchange. Now that's an additional £926, almost 26% increase in National Insurance contributions.
And if we apply that to the 100 employees at Royal London Sockets Limited, that's an additional cost of £92,600. However, if we use salary exchange, we can mitigate some of that cost. Remember, we're redirecting 50% of the employer's saving and this saves Royal London Sockets £146 per annum in National Insurance contributions for Sam. Of course, if we extend that out to the 100 Sams, then that saving would become £14,600.
We also mustn't forget about Sam. And although it's not shown here, you know, his pension contribution, as I mentioned earlier, has increased by £329 per annum. And I guess it, you know, it's not really rocket science to work out that if a 50% is redirected and that saves £14,600 if the employer doesn't redirect any of the savings.
And we're certainly not advocating that, but it is an option, and it may help to, you know, keep the employer, afloat, perhaps given the increasing costs. Then, of course, you know, if they didn't redirect any savings, then the saving would be double for the that the employer retained. I'm sure employers have already worked out what the additional cost, is, or what additional cost the National Insurance increase is going to make to their business, and the creating plans to try to offset this, you know, perhaps thinking about maybe downsizing or perhaps reducing salary increases or bonuses or increasing their charges, or probably a combination of all of these things and, and although salary exchange won't be right for all employees, and it can't mitigate all the additional costs, you can really add value by demonstrating how salary exchange could at least ease the burden. Okay. Now, we've always advocated salary exchange to employers, but for me, this demonstrates how salary exchange could be even more important to employers from April 2025. And of course, you know, we mustn't forget here, although I haven't factored into this, the employment allowance, which will reduce the total national insurance bill by a further, you know, £10,500.
Okay. So, our planning point here is to think about discussing salary exchange with employer clients who are not using it already. It's also worth, discussing with any individual clients who do receive an employer pension contribution that isn't part of a of a workplace pension scheme as well. Okay, now that I think we've probably had our fill of salary exchange for the moment, we're going to move on and look at tax traps.
Now, these are bands of income where due to the operation of some benefits and allowances, individuals can find themselves paying a higher, higher amount than their headline rate of tax. And to understand how tax traps work, I think it's really important to have a reminder of adjusted net income, as that's absolutely key. Now, first of all, adjusted net income isn't to be confused with adjusted income, although they sound very similar which was going to legislation drafters wasn't it.
Adjusted income is relevant when calculating the type of annual allowance. Instead, adjusted net income is total taxable income before any personal allowances and less certain tax reliefs. For example, trading losters, donations made to charity through gift aid, gross pension contributions to a net pay or a relief-at-source scheme. Now, adjusted net income will impact the rate of tax to be paid if a client is impacted by the personal allowance tax trap, which we're going to look at in just a second, where you have an adjusted net income over £100,000, and also it will impact the people, subject to the high-income child benefit tax charge, where, you have an adjusted net income above £60,000 and the relevant criteria for, the charge to apply. So how can a pension contribution can help? Well, first you have to calculate taxable income and then you deduct the pension contributions.
So, let's look at the personal allowance tax trap first. As soon as somebody has adjusted net income over £100,000 per annum, they start to lose their personal allowance on a two for one basis until it's all gone. At a salary at or above £125,140. Now, in this tax trap, the client is paying 60% tax, as you can see, over on the right-hand side of the screen.
Now it might be that somebody is consistently well, well over that threshold okay. Which might mean that even a pension contribution isn't going to solve their issue. But they can be occasions where clients are impacted by this saying one year only, for example, due to a redundancy or a bonus, and paying a pension contribution can really help.
Of course, there are also those clients who regularly earn between £100 and £125,000 who would, benefit, but I suspect that's more often dealt with by regular pension contributions throughout the year rather than, lump sums as tax year end approaches. Now, due to the differing tax bands. Okay, the figures will be different in Scotland, but the same, theory applies to, to the process that we're going to look at.
Okay. So just want to run through this case study to bring it to life. I am quite conscious that I don't want to bombard you all with numbers. So, I'm going to try and keep this as concise as I possibly can. So, if we start by looking at the before column okay, you can see that taxable income right at the top there £125,140.
And that gives income after tax of £78,000… we'll call it £111. Okay. Remember that last £25,140 of income is effectively taxed at 60%. Looking at the after column then by paying a net pension contribution of £20,112, which you won't be surprised to hear grosses up beautifully to precisely £25,140. This reduces the adjusted net income to £100,000 and therefore means the personal allowance is retained, effectively giving 60% tax relief on that pension contribution.
Okay, income after tax has only reduced by it's about £10,000, as you can see on the bottom row there. And this person now has £25,140 in their pension. As a result, with all the benefits, associated with being in a pension tax wrapper, you know, tax free growth, favourable IHT treatment at least until April 2027.
Anyway, now, I do acknowledge that some clients might rather have that extra £10,000 in their bank account. But you know what? The closer that the client is to 55, the more attractive the pension option becomes. You know, if they can access, 25% of that £25,140 that they just put in, which is £6,290, just like you having to do the maths, they can access that soon or even immediately, you know, it makes even more sense, doesn't it?
And remember this individual is still going to be a higher rate taxpayer. So, they'll receive a tax rebate of that, you know, £5,028 higher rate tax relief. So, between the peaks of, you know, about £6300 and the higher rate tax relief of just over £5,000, this individual could actually get over £11,000 back, which is actually higher than their income after tax before the pension contribution.
Okay. The differential there and still have almost £19,000 in their pension, looks a pretty good deal to me. Of course, if you go a step further and utilise salary exchange to make the pension contribution, the outcome is even better at 67% relief. Now, I'm not going to cover that in detail today, but if you want to know more about that, please have a look at our Technical Central website where there's a great worked example, on there that that takes you through all of that.
Okay. So, well planning point here is do you have any clients who've recently had a pay rise or redundancy for whom this might be relevant now as I mentioned earlier, don't forget about the clients who regularly have earnings between 100 and £125,000 each as it'll be relevant to them to. Okay, next, I just want us to consider the child benefit tax trap, and a pension contribution can help here as well.
Now, some of you may remember that when Jeremy Hunt was Chancellor, there was a discussion around the fairness of the child benefit system and specifically around it being based on the highest single earner in the household, rather than total household income. Now, that arose from the perceived unfairness that a couple in the household could each be earning £59,999, giving a household income of, you know, very nearly £120,000 and not incur a high income child benefit tax charge, while a household with a single earner earning £80,000 will attract a tax charge equal to the benefit amount, effectively wiping it out.
However, in the October 2024 budget, it was announced that the review into this will not go ahead due to cost. So, if you have any clients that have children in full time education and the highest earner in the couple earns somewhere between 60 and about £80,000, well, the high-income child benefit tax trap could impact them. And that's what we're going to look at next.
Do just remember as a as a point I know we'll probably won't come up very often. But it doesn't have to be your client's children. They could have moved in with a new partner who has children, and because they live in the household, they will be impacted. Okay. Now, due to this high-income child benefit tax charge, some couples, particularly those where the highest earner earns well, well over £80,000, have chosen not to receive child benefit anymore, so they avoid that tax charge.
Now, this is the child benefit application form that you can see on the screen. And you can see at section 62 it asks you if you want to be paid child benefit. And this is really important if one parent is going to be a stay-at-home parent, that person needs to complete the child benefit claim form to trigger entitlement to 12 years of National Insurance credits, which of course we know is crucial for State pension eligibility.
Now, that doesn't mean that you actually need to be paid the benefit. In fact, question 62 enables you to say that you don't want to be paid it, but you do need to complete the form to get the National Insurance credits. Now, if this form is not filled in for each child, then as well as missing out on the National Insurance credits, the child will also not automatically get a National Insurance number sent to them when they're almost 16.
And I can tell you that can have some real practical, issues actually, because 16 is around about the age that a lot of people are applying for learner driver permits and so on. If they've got a passport, they can use that for it. But if they don't, guess what, you can use the National Insurance form.
So not having that can be a little bit problematic there as well. Anyway, the previous government you may recall had, via an HMRC policy paper in January 2024, advised they would introduce legislation to enable those people who'd missed out on National Insurance credits due to, well, either not completing the form or the wrong person claiming it on the form.
You know, the working person rather than the non-working parent claiming it. So, they were going to introduce legislation, to make it possible to retrospectively claim those missed National Insurance credits. Now, the plan was for this to be possible from April 2026. And, these National Insurance credits could be claimed back to 2010, when the high-income child benefit tax charge began.
And thereafter, the plan is for it to be, possible to claim back the previous six years if credits were missed. However, with the change of government since then, it remains to be seen, if this policy will be taken forward and if so, the exact structure of it and the time and the timeframes. You know, we'll watch for developments on this with keen interest.
Looking at how HMRC forums, the HMRC responses still discussed the policy being available from April 2026, but they don't provide really any more detail than that. So that's as much as we can share with you at the moment. Okay, so let's quickly run through how a pension contribution can help with the high-income child benefit tax trap using a case study.
So here we have Tony and Lucy who live in England. They have two children. Tony has taxable income of £68,000 per annum, as you can see on the slide, which is £8,000 over that magic £60,000 mark with a high-income child benefit tax charge starts to bite. And this means that there's a tax charge of 1% of the child benefit amount for every £200.
Tony earns above that £60,000 figure. And the outcome of this is a child benefit tax charge of 40% of the benefit amount. Now, Lucy is a stay-at-home mother who claims the child benefit of £2,212.60. So, Tony receives a tax charge of 40% of the total amount of child benefit received by Lucy, meaning that he is paying 51.1% tax on that £8,000 of earnings.
However, we know, don't we, that pension contributions reduce adjusted net income. So, if he makes a contribution of £6,400 net, which is grossed up to £8,000 with basic rate tax relief, then his adjusted net income reduces to £60,000 and the high-income child benefit tax charge is avoided. Plus, Tony is no longer paying higher rate tax on £8,000 of his income, meaning he makes a saving of £3,200.
And you can see that down towards the bottom right-hand corner. So, we've got savings here okay. The tax saving is £3,200. Higher rate tax saving plus £895.04. That's the child benefit tax charge saving by not being subject to that anymore. If we add those together and divide them by the £8,000 that Tony needed to contribute to a pension to make all of this happen, you'll never guess it's 51.1% tax relief.
Okay, now that's all I really wanted to cover on tax traps just for today. So, what I'm going to do is I'm going to hand you over to Fiona to take you through the rest of the presentation.
Thanks very much, Justin. And hi, everyone. So, let's move on and have a think about one of the most common tax year end subjects, if not the most common one, the annual allowance and carry forwards.
And firstly, I want you to talk about the standard annual allowance, which is currently £60,000. Up until the 6th of April 2023, the standard annualised was £40,000, but it changed from that point to £60,000. So, ignoring any carry forward taper or money purchase annual allowance, this will be the maximum someone can pay into a pension or have paid in on their behalf in a tax year.
Really importantly, without a tax charge applying. Now, that might seem like a really straightforward statement, but you know, from speaking to my colleagues in the pensions technical team who deal with thousands of questions about pensions, it's quite common to get confused between tax relief and the annual allowance. For instance, you often see in pensions literature that the maximum you can pay into your pension is £60,000, but it's not really.
It's potentially the maximum you can pay into your pension without a tax charge applying. If, for instance, someone had earnings of £70,000 and wanted to pay in the maximum individual contribution into their pension, the maximum they can pay and receive tax relief, most importantly, is £70,000. If they've got no carry forwards available, and assuming there are no issues with the tapered or money purchase annual allowance, they would therefore have an annual allowance tax charge on those £10,000.
The difference between 60 and 70. So try and always think about the annual allowance being the amount that can be paid into your pension without a tax charge applying, rather than the kind of hard maximum that you can actually pay. And looking a bit closer at the rules around carry forward, it's a source of many questions, as we said, but I think that's because the rules have changed over the years, and I expect most advisers don't really deal with it from one tax year end to the next.
We know we receive the bulk of our communities between January and the start of the tax year. And you know, that's totally understandable. So, you know, please don't feel like you're alone. If you do have a question about carry forward, you can carry forward unused annual earnings from the previous three years and add this to your annual allowance for the current year, giving a total potential annual allowance, therefore, of £200,000 for this year.
If the taper part applies or applied in a previous year, it's still possible to use carry forward. You simply substitute the standard annual allowance for your tapered annual allowance in your calculations for the relevant year. If you're looking to calculate someone's unused on your loan, it would be wise, therefore, to get a history of contributions that make sense, but potentially a history of income too.
If you think the tea pot is likely to apply either in the current year or that previous year. You must have been a member of a pension scheme in the year that you're carrying forward from in order to be eligible to use carry forward for that earlier year. Now, that definition of member is really broad. You could have been an active member of a scheme, meaning you were actively accruing benefits or paying contributions.
You could have been a deferred member, meaning you were previously a member of a scheme but had left. You could be a Pension Credit member, meaning you've set up a pension plan which has received a Pension Credit in respect of a divorce. So, in theory, nobody even having paid a pension contribution yourself. Or finally, you could be a pensioner member, meaning you're receiving a pension income from that pension scheme.
So really then, the only people not eligible for carry forward are those taking out a pension for the very first time, as they wouldn't meet any of those definitions of ‘member’ for carry forward purposes. One point worth mentioning here is that even if individuals have lived abroad during the previous three years, they could still meet the definition of member for carry forward purposes and be able to make contributions and use carry forward if they are now back in the UK with pensionable earnings for this year.
An important point about how you carry forward works is that you maximise your current year's allowance first, before going back to the earliest of your three years, and then you work forwards. The reason why this is worth remembering is that if you're looking at a client's history of contributions, and you can see in a previous year they've paid in more than £40,000 or £60,000 for last year, you know that for that year they'll have no annual allowance left to carry forward, as they must have maximised that year first before carrying forward.
And that helps greatly with any calculations where there has been a previous calculation done, because you can simply cross that year out as you know it wouldn't be relevant. As you may be aware, those with fixed or enhanced protection have been able to contribute to a pension again since the 6th of April 2023 without losing their protection. A common question recently, therefore, has been are people in this situation able to use carry forward?
And the answer is yes, because they meet the definition of member for carry forward purposes by virtue of being a deferred member, and therefore have in theory, that full £200,000 annual allowance available. Here we've got a quick visual to show how carry forward works. In this example, the individual pays and £5,000 each year, leaving unused annual earnings of £35,000 for the first two years in our calculation and £55,000 for last year. tax year 2023-2024.
Adding this unused annual allowance of £125,000 to the £60,000 standard annual ends for this year means total available annual allowance of £185,000. Another way to think of that would be your totals 200 less the £15,000 that you've already paid. Use whichever is easier for you to understand. As mentioned earlier, this £85,000, this is the maximum the individual can pay or have paid into their pension scheme on their behalf without a tax charge applying.
If this is an individual contribution, the member will still need earnings of at least £185,000 in this tax year to receive tax relief on that full contribution. If this is an employer contribution, this 100% of earnings rule doesn't apply and the company should receive corporation tax on the contribution provided the wholly and exclusively rule applies or there are no issues with it.
Remember, both employer and individual contributions count towards the annual allowance, as you need to have been a member of a pension scheme in the year that you're carrying forward from, as we just said. If someone thinks that they might want to meet use of carry forward in the future, but they don't currently have a pension, it's definitely worth starting one.
Even with, you know, a tiny contribution to therefore ensure or open up carry forward to that person in the future. So, our planning point here then is make sure clients are aware of the maximum they can pay, and without a tax charge applying it might be more than they think. I remember that point about those who didn't don't currently have a pension and carry forward being available to them potentially in the future.
So, moving on from annual allowance and carry forward. Let's have a think about capital gains tax and what those changes were in the budget. A little reminder firstly of how it works. Capital gains is a tax on the profit when you sell or dispose of something that's increased in value, it's the gain you make that's tax, not the amount of money you receive.
For example, if you bought a painting for £5,000 and later sold it for £25,000, that means you made a gain of £20,000. Some assets are tax free and also you don't have to pay capital gains tax of all your gains in a year ARE under your available tax-free allowance, which is called the annual exempt amount.
And this has changed over the years. Up until the 6th of April 2023, it was £12,300. Then it reduced to £6000. And from April 2024 it reduced again to just £3,000. For a residential property which you don't actually live in or isn't your main home, the rates of tax are 18% for basic rate taxpayers and 24% of higher rate taxpayers, if you're selling that or just using it for capital gains tax purposes. Residential property excludes your main home, unless you rent out or it's very large and unused for businesses.
For all other assets, the rates of tax increased from 10% to 18% for basic rate and from 20% to 24% for those higher rates. Importantly, that was with effect from the 30th of October 2024, the date of the budget, in other words, that was the mid-year. This now means all gains are taxed at the same rates.
Now, I mentioned a minute ago about disposing of an asset and that includes or could mean selling it, giving it away, or transferring it to someone else, swapping it for something else, or getting compensation for it like an insurance payment.
If it's been lost or destroyed. You don't usually pay tax on gifts to your husband, wife, civil partner, or a charity, and you don't pay capital gains on certain assets, including any gains you make from ISA’s or going back a bit, PEPs, UK government gilts and premium bonds and betting wins, lottery winnings or pools winnings, that kind of stuff.
When you inherit an asset, inheritance tax is usually paid by the estate of the person who's died. You only have to work out if you need to pay a capital gains tax. If you later on dispose of that asset. So, what planning can be done though then if you find yourself facing a capital gains tax bill, which could be different now as a result of the budget changes.
So, let's look at an example of where a pension contribution can help. And let me introduce you to Mira. She inherited a painting a few years ago, but she's now disposing of it. After her current annual exam to might has been deducted, there's a gain of £10,000, but that gain has pushed Mira into the higher rate tax band.
And that means she has to pay 24% capital gains tax. If she was a basic rate taxpayer, it would have been 18%. So, she has an income tax bill of £7540, plus a capital gains tax charge of £2400. So, her total tax bill is £9940. But let's say Mira has a retirement income need, and if she pays a pension contribution, then that is a really great way of saving tax and satisfying that retirement income needs.
If she pays a net contribution of £8,000 using some of that money from that sale, then that's grossed up to £10,000 immediately by the provider, but also increases her basic rate band by £10,000, which means that her total tax bill will reduce from £9940 to £9340. That's because she won't any longer be paying higher rate capital gains tax.
So, our capital gains tax bill will decrease from £2400 to £1800, 18% instead of 24%. So, the saving together with that £2,000 tax relief that she'd get on the pension means 26% tax relief. So, for a net spend of 7400, Mira has saved £600 in capital gains tax. And she's also increased her pension by £10,000.
So, our planning point here when it comes to capital gains taxes, can pensions help to reduce the capital gains tax bill? Are people getting closer to retirement and that's it worth swapping from one asset to another. And this is obviously a really important tax year end consideration as after the 6th of April it will be too late.
Okay. Let's have a think about inheritance tax. And this just and said I have a feeling that we'll be talking a lot about this, in 2025 and 2026 unfortunately.
Firstly, let's have a think about what we do know about inheritance tax and pensions following the budget. At the end of October, well, the budget announced that inheritance tax would apply to pensions from the 6th April 2027. So, it's worth noting, first of all, that it doesn't take effect, you know, for more than two years. But of course, it has the potential to impact many of your clients’ financial plans.
And of course, might involve changes to the strategy you employ for them. You know, well before then. But there are still some unanswered questions about how it works. And there was a consultation which closed on the 22nd of January, and we need to wait for those consultation responses. So, some of these points may remain unknown, certainly for months to come.
The proposals, as we know it seem to apply to most types of pension plan, and there's very little out of school. As you can see, the charity, lump sum, death benefit and dependent scheme pensions are out of scope, but, you know, pretty much everything else is in scope. Much of the consultation concerns the mechanics of actually paying inheritance tax charges as they arise, and the current proposal will see scheme administrators deducting any inheritance tax due and paying that over to HMRC before those pension proceeds are paid to any beneficiaries, but will need to wait on further clarity about how exactly that will work in practice.
There's still quite a lot that's not clear, and we're already receiving lots of questions from advisers around how it will work and what actions they and their clients should be taking now or at least thinking about now. You can see some of those that we've sort of put together on screen now. Should I be thinking about gifting now or what should my clients be doing now?
And that's a really difficult question to answer, not only because we don't have the consultation response yet, but also because it's so particular to the individual circumstances as well as the beneficiary circumstances. In most instances, it will make sense to wait until we've got further detail.
Will the payment of death benefits be delayed? And that's definitely a risk.
Is there going to be further checks and interaction between the scheme administrators and personal representatives before any money can be paid out under that current proposal? And as I mentioned, much, you know, much of that consultation is focused on how to avoid delays or how, you know, I would hope there would be death and service benefits could be included, which perhaps might be unexpected.
And we're getting questions around the order of taking benefits and whether that's likely to, likely to change. And I can totally understand that, given the perceived wisdom previously or still, you know, even right now, it's often to take benefits from everything. Subject inheritance tax first, like your ISA on pensions later as you're exempt from inheritance tax.
But you know, in the future, if there's not that differential anymore, then there could be some changes around the order of taking benefits, but it will be particular to each client and how you pension death benefits paid into trust will be impacted. When we have more details on the changes, we are going to have a webinar covering both protection and pensions.
So definitely worth watching out for that one coming up in the future. So, there's lots of valid questions, but for many of them, it's just too soon to be able to answer them.
I thought it might be useful if we had a quick recap on inheritance tax works. If you're so used to dealing with pensions and, you know that inheritance tax knowledge might be a bit rusty because your clients might be wanting to make some gifts now as a result of the budget announcement. So firstly, inheritance tax is payable on death where the deceased estates is valued at more than 325,000.
But there's also the Resident No Rate Band, which has a further £175,000 available if you own the property that you live in, both the No Rate Band and the Resident No Rate Band are transferable to a spouse or civil partner. So that really means that for a married couple or a civil partnership, there's a potential for an overall No Rate Band of £1,000,000, if there's a house, anything above that is subject to the inheritance tax charge of 40%, and we also know from the October 2024 budget that these allowances have been frozen until 2030.
Aside from the No Rate Band, so there's a number of exemptions that enable gifts which aren't subject to inheritance tax, which, you know, I've been around for a while and are valid planning and will probably become something we talk a lot more in the next year or so, and we've got some of them listed here.
Perhaps the most significant of these is the spousal exemption. So even with the proposed changes to inheritance tax on pensions, remember that transfers or gifts between spouses or civil partners are not subject to inheritance tax. And that's pretty significant given the increase in the use of income drawdown as a retirement vehicle in the last decade. Even when pensions are subject to inheritance tax, there will be that spousal exemption when one person in a couple dies and leaves the pension fund to their spouse or civil partner, meaning no inheritance tax will be due in most instances. Small gifts of up to £250 makes it possible to give £250 per annum to an unlimited number of people, without these being subject to inheritance tax.
Marriage gifts can be made, although the amount varies depending on who it goes to, but up to £5,000 = can be given to your child without it being subject to inheritance tax, if they're getting married. There's the annual gift allowance, which is a total of up to £3,000 per annum that can go to anyone.
And I think we're probably all pretty familiar with that. Any part of the annual exemption, which isn't used in a tax year, can be carried forward to the following year. But, you know, you can only do that once. You can't carry on further after that point. And you also can't combine that exemption with some other exemptions. For example, you couldn’t give someone £3250 combining those exemptions.
Exemptions for gifts to charities and political parties are also available. And when it comes to payments to help with cost of living, that's probably one you may have heard less about. What we're sort of seeing here is that things like a parent paying for university accommodation, or perhaps of a parent directly paid for a wedding venue for a child's wedding, rather than gifting the money first to them.
These get things out of the estate and maybe don't fall neatly within the other exemptions listed here.
And lastly, I think the one we'll talk most about over the next couple of years is that normal expenditure of income. And because this is one of the more under-used exemptions, and I'm sure it's definitely going to be quite prescient when inheritance tax is introduced for pensions in 2027, it's definitely worth giving it some thought for a disposal to qualify as a gift out of normal expenditure needs to meet the criteria you can see on the screen.
So, it needs to be made out of normal expenditure. So, part of that will involve it being regular. It needs to be made from income rather than capital, and the person giving the gift out of normal expenditure still needs to be able to maintain their standard of living. After making the gift. It's really important to remember that if you're relying on using any of the exemptions, it's really, you know, absolutely recommended to keep decent records.
I would suggest for a normal expenditure of income using this extract from the IHT form IHT 403, as it gives a really good way of keeping a record of any gifts out of normal expenditure. It's also worth remembering that contributing to someone else's pension is a great way to help them and reduce the amount of inheritance tax payable, together with potentially reducing the recipient's income tax, they can also benefit from income tax relief.
The annual exemption of £3,000 that we talked about can be used for this, but using the normal expenditure of income exemption means that potentially much higher contributions can be paid. And remember the figures that are relevant here are those net contributions.
How do these contributions work for inheritance tax purposes?
Well, those contributions will be exempt or potentially exempt. If there isn't a valid exemption, then they will become PEPs or potentially exempt transfers. And that seven-year rule would apply. For the individual receiving that pension contribution, as a third-party payment or a gift, the amount of the contribution must satisfy the relevant earnings test as if the individual was making that contribution themselves.
So, let's say the contribution was for a grandchild who's five. Then the maximum that could be contributed net would be £2880, which would be grossed up to £3600, the maximum that can be paid if there are no earnings. Of course, if the grandchild were a child film star and had lots of earnings, anyone could, who earns, let's say £50,000, let's say that was the child, then the maximum contribution would be £50,000 that would be eligible for tax relief, less any contributions that are being made currently. If that recipient is a high-rate taxpayer or an additional rate taxpayer, then they would claim that additional or higher rate relief, not the person making the contribution. The pension itself would be growing within a tax efficient wrapper that will help with that retirement income need.
And it's also got the advantage of the grandparent or parent knowing that that child or grandchild can't access that money until they're at least 55. Which of course, as we all know, soon to be 57. But they could benefit from that tax relief well before that point. If they are at a higher rate or additional rate taxpayer, and perhaps even get them out of a tax trap, as Justin discussed.
So, our planning point here is just keep an eye on that consultation and think about gifting during lifetime, if any of your clients are paying for their beneficiaries to reduce or avoid inheritance tax.
So here are our learning outcomes that we that we talked about at the start. At the end of the session, you'll hopefully now be able to outline the changes to the taxation announced in October 2024 budget, describe the tax traps and how to avoid them using pensions; explain some intergenerational tax planning opportunities and explain how pensions can help with a capital gains tax charge.
Thank you for watching today. Look out for the link to download your CPD certificate and I look forward to speaking to you again in a future webinar. Thanks very much.
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