Downturn adds urgency to annual exercise

With the end of the tax year just a week away, investors need to move quickly if they want to take advantage of tax breaks and allowances that are otherwise lost on April 5.

Growing fears that taxes will have to rise to pay for soaring government borrowing in the recession should be a further spur for making use of available reliefs, say experts.

Patricia Mock, director of private client services at Deloitte, the accountants, describes using up tax allowances and making tax-efficient investments as “good housekeeping”. “More people are thinking about ways of saving tax because of the general desire to economise and take greater care of their money in the downturn,” she notes.

Individual savings accounts (Isas) are the most well-known “use it or lose it” tax break with an April 5 deadline. Individuals can put up to £7,200 into Isas per tax year, of which £3,600 can go into a cash Isa. A couple can therefore double these amounts.

Despite low interest rates, cash Isas are still attractive. Best-buys are currently paying up to about 3.5 per cent and, because interest is tax-free, for a higher rate taxpayer this is equivalent to earning 5.8 per cent on a normal savings account.

Many stock-market Isas allow investors to take up their allowances but keep contributions in cash until they are comfortable moving into shares.

Experts also say that investors not wanting to commit new money to a stock-market Isa should at least consider using their allowance to ringfence existing portfolio holdings from tax, through “bed and Isa” transactions. These involve selling an investment held outside an Isa, then buying it back within the tax shelter.

Fidelity, a fund manager, says investors should prioritise these transfers according to the relative tax efficiency of Isas for different assets. Holding UK fixed interest investments in an Isa boosts income returns by 67 per cent for a higher rate taxpayer compared with keeping a fund outside the tax shelter. UK property funds are the next most tax-efficient asset for an Isa investor who otherwise pays 40 per cent tax, followed by UK equity income holdings, then growth-oriented shares, says Fidelity.

With stock markets close to multi-year lows and property prices falling, capital gains tax (CGT) may not seem an obvious problem for many investors. But where individuals are fortunate enough to have made investment profits – perhaps on a buy-to-let flat they have held for many years and have just sold – their 2008/9 CGT allowance means there is no tax to pay on the first £9,600 of gains. And they can use losses on other investments to reduce bigger gains.

Losses cannot be carried back to previous tax years, so someone wanting to offset gains from this tax year needs to crystallise losses by April 5. These can also be carried forward to use against future gains.

Contributing to a pension is a common way for higher-rate taxpayers to reduce income tax bills. Some high earners could wipe out their higher-rate liability by investing most of their earnings over the current 40 per cent threshold of £40,835.

However, while contributions need to be made before April 5 to cut 2008/9 liabilities, experts say that the high level of flexibility in the amounts that can be paid into pensions also means that many investors can afford to delay their retirement funding until later in life: for example, when they have a higher disposable income or an inheritance that they are happy to lock away. Income tax relief at up to 40 per cent is available on contributions of up to £235,000 this year, subject to individuals having sufficient earnings from employment or self-employment, rising to £245,000 for 2009/10.

Given that pension monies – unlike with Isas – are tied up until retirement, Adrian Lowcock, senior investment adviser at Bestinvest, warns investors only to make contributions they are sure they can afford – even if they were to lose their job, for example.

Alternatively, “bed and Sipp” contributions – similar to bed and Isas – allow investors to gain tax relief through a self-invested personal pension without the need to commit more cash.

Upfront income tax relief is also available on investments in venture capital trusts (VCTs) and enterprise investment schemes (EISs), at 30 and 20 per cent respectively. In addition, EISs offer the ability to defer CGT on previous investment gains. However, Deloitte’s Mock warns that especially with these schemes– which involve investing in start-ups and small businesses – individuals should beware of being overly led by the tax perks. “You’re getting a tax break but in a much more risky investment,” she says.

Older people with surplus wealth could also consider gifts to children and other family members to reduce future inheritance tax bills. Individuals can make IHT-free gifts of up to £3,000 per tax year – there is no need to survive seven years as with many larger gifts. If 2007/8’s gift allowance was not used, this is also available until April 5 – giving a tax-free gift total of £6,000.

Experts say tax planning should not be confined to the run-up to April 5. Says Alan Dick, director of consumer affairs at the Institute of Financial Planning: “The tax-planning season is merely a marketing idea dreamt up by accountants and financial advisers . . . Planning should be under constant review . . . (even) on the 6th of April.”