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Tax Doctor: Pensioner protects inheritance through tax tweaks

To protect her dividend income from being taxed at a higher rate under new rules, Mrs Garcia can consider a range of savings options, from spousal allowance to investment bonds

Tax Doctor: Pensioner protects inheritance through tax tweaks

To protect her dividend income from being taxed at a higher rate under new rules, Mrs Garcia can consider a range of savings options, from spousal allowance to investment bonds.

THE CASE

Mrs Garcia is 70 and she has been a stay-at-home mum and housewife for most of her adult life. She receives a basic married women’s state pension of £3,926 a year. However, 10 years ago she invested a £450,000 inheritance into dividend-paying stocks, which give her a dividend income of around £18,000 per year.

The dividend allowance decreased from £5,000 to £2,000 in April 2018. Mrs Garcia is one of the estimated 2.3 million individuals who now have to pay more tax on their dividend income.

Due to the reduction in the dividend allowance, instead of paying £407 (as she did in the 2017/18 tax year) in income tax, she will now pay more than £605 for the 2018/19 tax year.

THE PRESCRIPTION

Simple planning can reduce or avoid the effect of this reduction.

The ISA allowance for 2018/19 remains £20,000. Mrs Garcia should ensure this is utilised in full as a first step. This is because dividends received in an ISA do not count towards the allowance.

Reducing investments held outside tax wrappers by placing the money into an ISA known as ‘bed and ISA’ can shelter the dividend yield from personal taxation. A bed and ISA transaction would allow Mrs Garcia to sell her existing investments and use the proceeds to top up her ISA account.

If she wanted, she could then buy the same investments back, choose other investments or simply keep the cash in her ISA. Doing this can also help Mrs Garcia utilise the annual capital gains tax (CGT) exemption.

Spousal allowance

Mrs Garcia’s husband could help her make the most of the tax allowances available. Each individual has the following for 2018/19:

  • a personal allowance (£11,850) starting rate for savings (where earned income is below £16,850);
  • a personal savings allowance (£1,000/£500/£0 dependent on earnings);
  • a dividend allowance (£2,000).

As all the investments are held in Mrs Garcia’s name, there is an opportunity to transfer some investments to Mr Garcia to ensure these allowances are used to the couple’s advantage. This is assuming he is not already using these allowances.

Similarly, if the transfer of investments is done in specie between spouses living together, this does not create a CGT liability.

Investment bond

A life assurance (or redemption) bond could help shelter Mrs Garcia’s investments from dividend taxation as the ownership of the investments yielding the dividends is the life company. Because of this ownership structure, dividends earned in the bond wrapper do not count towards the dividend allowance and are not liable to personal taxation while invested.

Investment bonds are taxed under chargeable event rules. Further consideration is required to her net position on surrender to ensure the client is not liable to higher rates of tax on the bond gain than on receiving the dividends.

Interest and capital growth

If Mrs Garcia has already taken advantage of the above suggestions, she could still review the way investment returns are achieved with some coming from interest and capital growth. This will depend on Mrs Garcia’s attitude to risk but it could help reduce the dividend income received.

Gordon Andrews is a financial planning expert at Old Mutual Wealth

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