Welcome to the December 2018 newsletter from Chamberlains
Firstly, Happy Christmas from all of us here at Chamberlains.
It’s been a challenging year for many (not least our politicians – and in part for us due to those noble souls who supposedly serve us in Westminster!)
Ah well, perhaps the New Year will be better and things will be clearer – let’s hope so… Actually, 2018 has been a good year for Chamberlains. Shelene, our office manager, had joined us in autumn 2017, and Nikki, our third manager (after the long-serving and invaluable Keith and Vikki) joined us the next January – and the team settled down amazingly quickly and worked together to the general satisfaction of one and all.
In the New Year our neighbours at Tanshire Park are moving out, and we’re hoping to agree with The Management to take on their space – at the moment we’re sometimes a little cozy and it would be nice to have the option to allow more people to join the team as time goes on.
One of the less welcome dates for taxpayers in any year is 31st January. This is when any remaining tax needs to be paid for the tax year ending the previous 5th April. The trouble is that there’s often a double-whammy because the first payment on account (“POA”) for the next year is due at the same time. Sometimes people have become self-employed or subject to extra tax for the first time in the previous year (maybe they’ve received extra dividends or rental income), and this can be a nasty surprise.
It’s often confusing, so perhaps an example would be helpful. Let’s say that in the year ended 5 April 2018 Vilanelle ends up with a tax bill for £10,000 after all personal allowances and deduction for tax paid along the way. This is the first year that she’s had to pay non-PAYE tax, and she’s been busy on a number of new assignments. And the next two years she does even better and is due to pay £12,000 each year.
In basic terms, she pays tax in the January following the end of each tax year. However, once this is above a fairly low amount, HMRC also wants to receive Payments on Account of half the expected amount in the January just before, and the July just after, the end of the tax year. Her tax would be due as follows (payments at each date are shown underlined in bold):
If you follow it through, you’ll see that after the first nasty shock of a large first tax bill PLUS a first payment on account, things settle down, and, if her tax stays at £12,000, Vilanelle will continue to make six-monthly payments of £6,000.
So far, so good. However, despite the payments on account, she’s almost always paying tax in arrears. Tax is based on an accounts year that ends in the relevant tax year. (There are special rules for the first and last years of a business, but let’s not make life difficult for ourselves here!)
If her accounts year ends on 30 April, the tax that she’s paying for 2020/21, the year ended 5 April 2021, will be on the profits she made in the accounts year ended 30 April 2020. So she pays tax on her profits in the year ended 30 April 2020 on 31 January 2021, 31 July 2021 and perhaps more on 31 January 2022 if her profits are increasing. In other words there’s quite a gap between earning the money and paying the tax – good for temporary cashflow, but dangerous if she’s spent it!
The moral of the story is… that it’s best not to leave the accounts and tax forecasts too late, even if it means paying your accountant earlier for his work! Please get in touch to talk about this, but not until after end of January, please! (There are quite a few tax returns still left to be done.)
Another good reason for not leaving things until the last minute is that payments into pension schemes can be a good way of saving tax – not to mention being a good way to get a better pension!
I’ve explained how these work before, but a reminder is often helpful. The main idea is that the government encourage us to have private pensions, so they help us along in the right direction. Firstly, if you pay in £800, they top it up to £1,000. So the £1,000 in your pension pot has only cost you £800.
You can tell your pension provider what to invest it in, depending on what level of risk you’re happy with. In general, riskier investments have to pay more to persuade people to invest in them, and their values tend to go up and down more than safer investments – they’re more “volatile”. However, over a longer period, they often do better than the safer ones.
People are often worried about the investments in the pension fund – what if they go down? And indeed the current stockmarket has been a bit negative of late (after a period of good growth). I recently received an investment statement for the quarter ended 31 October and my little pot had gone down by 5.5% in that time. Am I worried? Not particularly, because I look back at what it cost me and I can see that this loss is well within HMRC’s contribution to the fund – so I’m still winning!
In other words, the initial extra 25% that the government give us (£200 on top of the £800) is easily able to cover all but the worst falls in the value of investments. But it’s better than that – they give even more help to higher rate taxpayers. Mr Goodearner gets an allowance for the £1,000 on his tax return by an extension to his basic rate band. It’s an odd way of getting extra tax relief, but it still works! Normally, you get the first £11,850 income tax free, the next £34,500 (the basic rate band) is taxed at 20%, and then tax is at 40% until £150,000.
Imagine that Mr G earns just £1,000 above the basic rate band – so that’s £11,850 + £34,500 + £1,000 = £47,350. He’ll have tax of £34,500 at 20% and £1,000 at 40%: £6,900 + £400 = £7,300. However, if his basic rate band is extended by £1,000 by his £800 pension contribution, he’ll pay tax at 20% on the full £35,500, and that’s now £7,100. Hey presto – he’s saved himself £200 tax!
The result of this wonderful generosity by HMRC is that his pension pot of £1,000 has only cost him £600. To recap, this is because HMRC give £200 to top up his £800 up to £1,000, and then he gets a tax refund of another £200 via his tax return. And that £400 buffer more than caters for quite a bit of downward volatility in investments… (Hopefully your pension provider will have dissuaded you from investing everything in Carillion! Some investments can be disastrous, which is why it’s never wise to have all your eggs in one basket. The spread-portfolio idea is quite interesting – perhaps I’ll talk some more about it another time.)
In fact it can be even better than this if your income is a little over £100,000. This is because above that figure you start to lose your personal allowance – the tax-free £11,850. This is phased out up to £123,700, and in that band you’re effectively paying tax at an eye-watering 60%. So your pension contributions become even more worth while.
Of course, things have to be done correctly, and pensions are a complicated area. However, there are a few basic rules to obey:
1. The pension payment must be made in the relevant tax year. You can’t wait until after 5 April 2019 before you pay if you want to apply it to your 2018/19 tax return to get your higher rate allowance.
2. There are limits as to how much you can pay in. The grossed up amount (ie. the £1,000 version rather than your original £800) must not exceed £40,000 in any one year, nor can it exceed your earnings.
3. There’s a lifetime allowance for the value of all your pensions – currently £1,030,000. It is possible to go above this, but tax then becomes very expensive. (It’s too complicated to go into here, especially as it doesn’t apply to many people.)
The second rule is also quite complicated. If you haven’t used the £40,000 in previous years, you may be able to use unused amounts from the last three. However, it still can’t exceed your earnings in the year of the pension contribution. In other words, although you might have spare £40,000s to be able to get to £120,000, you can only use up to your current year’s earnings level.
A further complication is in the definition of “earnings” – or strictly, “net relevant earnings”. This excludes any investment income, including dividends that are often taken instead of a salary. However, there’s a concession even if you earn nothing: you can still pay in £2,880, which gives you a pension pot of £3,600 each year, thanks to the HMRC top-up.
One of the highlights of my day is the email from the Oxford English Dictionary with their word of the day. (My excuse for this sad admission is that, many years ago, I used to be involved in writing Spanish-English dictionaries.) They recently sent me “Energy Vampire” – originally a science fiction term, meaning “A being which feeds on energy”, for example, “The threat to human survival is posed by energy vampires from a remote planet”. However, it’s sometimes also used for “A person regarded as one who drains enthusiasm and emotional or mental energy from others, esp. by demanding a great deal of attention or care. Also used of an emotion, situation, task, etc.”
Do you know anyone like this? We’ve recently been dealing with a certain Tax Inspector (who shall remain nameless) who seems to fit this category very well. Depressing both for the taxpayer and for us, but at least we can try to ease the strain. On the other hand, I’ve just repelled another tax inspector by the exotic name of Tatiana– very satisfactory both for me and my client!