Make the most of your tax allowances

The tax year end is in sight. Are you confident you have made full use of your 2005/6 tax breaks and allowances before 5 April? Remember also that future tax planning options could be affected by Budget 2006 (22 March).

Many fiscal commentators are of the view that Gordon Brown will push for further tax rises given the presence of a £10 billion "black hole" in public finances. In Budget 2005 the Chancellor confirmed that the limits on individual savings accounts (ISAs) would stay at £7,000 for stocks and shares maxi-ISAs and £3,000 for cash mini-ISAs through to 2010. Use it or lose it!

This tax allowance really is a no-brainer, particularly where a cash ISA is concerned; all future interest accrued is free of income tax. Even if you are making no other tax efficient haven't already done so, scrape together money lying in non-productive bank and building society accounts and take out a cash Mini ISA before the end of the month.

The interest return on cash ISAs varies between providers depending on such aspects as instant access, notice of withdrawal, the existence of variable and fixed rate offers and whether transfer penalties are imposed. Don't be swayed by headline bonus rates; do your research and make comparisons based on the AER (annual equivalent rate).

The maximum that can be invested in a stocks and shares Mini ISA is now £4,000 (formerly £3,000), if you haven't already decided to invest the whole £7,000 allowance in equities. Confidence in the equity market is returning (and about time too, three years into a bull market!). The FTSE 100 index rose by 22% in 2005 and, according to the Investment Management Association, sales of equity ISA funds in January 2006 reached £82 million, double that achieved a year earlier.

Both basic rate and higher rate taxpayers do not pay any capital gains tax on such investment ISAs, although last year the Chancellor withdrew a 10% tax credit for dividends obtained from shareholdings. If a medium term view is taken (say 5 years or so) then there is a good chance of receiving a better return than you will get from a cash ISA.

Up to £200k and a tax bill? Be venturesome!

Assuming you suffer enough tax against which to use the relief, you may wish to consider the 40% income tax rebate on Venture Capital Trusts (VCTs). This opportunity ceases on 5 April, unless the Chancellor has a change of mind. Both spouses can invest up to £200,000 in a VCT (shares of unquoted companies and those listed on the Alternative Investment Market), but the 40% only holds for new VCT investment and the shares must be held for at least 3 years.

A long term view is necessary; there's not much demand to buy an existing VCT as there's no tax break - so no real exit. Hold onto the shares and benefit from the tax-free income (5 to 7%) that many of the trusts aim to pay after 3 or 4 years.

Up to £200,000 may also be put into an Enterprise Investment Scheme. To qualify for the 20% income tax rebate, shares have to be held for 3 years. Capital gains tax (CGT) can be deferred on gains realised within a specified time frame. Remember, if you don't use your CGT allowance (£8,500) for 2005/6, it cannot be carried forward to next year; consider realising investment gains or placing more of your portfolio under the tax-efficient ISA umbrella.

If married, then one spouse may sell shares, whilst the other immediately repurchases a similar amount, thus using up one CGT allowance while resetting the capital gains clock to zero for the other. Make full use of your personal allowances. Tax bills can be reduced for married couples by the transfer of assets to the lesser earning spouse; gifts between spouses are tax-free so it's possible to double the tax exemptions available by donating shares or other investments.

On the subject of gifting, inheritance tax (IHT) rules allow the giving away of £3,000 per year with a one year carry forward. Thus a married couple could reduce a potential IHT liability by handing over £12,000 to their children before the end of the tax year.

Is there scope to put more into a personal pension scheme before 5 April and thus increase the amount of tax relief on earned income? What about a stakeholder pension scheme which gives basic tax relief even for non-taxpayers and children (a £3,600 gross contribution effectively costs £2,808)?

Consider setting up and maximising contributions to a funded unapproved retirement benefit scheme (FURBS). Although there's no tax relief on contributions from salary, a FURBS holding is currently not regarded as part of an estate for IHT purposes, whereas such a scheme set up after 6 April will be IHT liable. Finally, don't overlook the fact that certain National Savings investments are not subject to tax if held for a specified period and £25 per month tax free can be put into a friendly society account.

09 March 2006 © Moneyextra.com

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