Do you know what your tax-free allowances are? Our friends at Nutmeg are here to help. They’ve summarised what each of the tax-free allowances are for products like your ISA, Junior ISA (JISA), Lifetime ISA (LISA), and pensions to help you make the most of your yearly allowance.
What is a tax-free allowance?
A tax-free allowance is a sum of money you can save or invest in one year without having to pay any tax.
ISAs, JISAs, LISAs, and pensions are examples of products that have specific tax-free allowances.
A general investment account (GIA) however does not have any tax-free allowance, which means everything within it can be taxed.
When does the tax year end?
We commonly think of each year ending on December 31st, however the UK tax year, often referred to as the financial year, ends on April 5th.
The end of the tax year is important for investors because after this date you are no longer able to put money into your tax-free allocations from the previous year.
You have a total of £20,000 per year to invest in ISAs tax free (although this may be subject to change in the future). Anything above that allowance you may have to pay tax on, including any growth from that investment.
If you don’t invest all your £20,000 in time, and have cash to invest, then next year you may need to go over your allowance and that additional amount will not enjoy the tax benefits of an ISA.
Why do you need to make the most of your yearly allowance?
Understanding these allowances will help you make important investment decisions– such as whether to invest more this year or wait for the new tax year. This is really important as an investor because it can have a big impact on the tax efficiency of your portfolio.
When it comes to investing for a long-term life goal such as retirement, your compound returns can be critical. Ideally, you want to make sure your money is growing by seeing returns on your returns.
If you are subject to income tax or capital gains tax on your investments, then this can eat into your growth and reduce the subsequent compound returns, effectively increasing the amount you lose as a result.
By the time you get to retirement age that could be the difference between retiring straight away or working for several more years.
1. What is the tax-free allowance for an ISA?
This is the total amount you’re allowed to put into ISAs for the 2020/21 tax year. So, whether you’re investing in a stocks and shares ISA, a LISA (The maximum annual tax-free allowance for a LISA is £4,000), a cash ISA, or an innovative finance ISA, you have a total of £20,000 to invest tax-free for that tax year. You may invest in one of each different respective ISA per year but your cumulative investments in ISAs must not be above £20,000.
2. What is the tax-free allowance for a LISA?
£4,000 (as part of your £20,000 ISA allowance)
This is the total amount you are allowed to put into a LISA for the 2020/21 tax year. The government will then add a further 25% for anything you add within a tax year. So, if you used up all your LISA allowance and added the full £4,000, the government would then add a further £1,000 (25%) to bring it up to a total of £5,000.
What’s important to remember is that whatever you put into a LISA counts towards your total £20,000 allowance for ISAs. If you put in £4,000 you will have £16,000 left to invest in other ISA vehicles for that tax year.
3. What is the tax-free allowance for a JISA?
You are allowed to invest £9,000 per year for each child in a JISA tax-free. This does not affect your £20,000 ISA allowance as the money belongs to the child in whose name the JISA has been set up.
4. What is the tax-free allowance for a pension?
£40,000 (kind of)
The government actually gives you tax relief on your pension. This relief applies to 100% of your earnings, or the government set annual allowance which is currently £40,000 – whichever is lower.
So, if you saved £32,000 via regular pension contributions over one tax year, and assuming your income was at least £32,000, the government would top up your pension by 25% (£8,000). This is actually a 20% tax-relief because that £8,000 makes up 20% of your total pot of £40,000.
If you’re a higher-rate taxpayer, you can claim a further 20% tax-relief and if you’re an additional-rate taxpayer you can claim an extra 25%.
If you live in Scotland the tax relief rates work differently.
Remember: your tax relief counts towards your total pension contributions and therefore affects your annual tax-free allowance. So, don’t forget to factor this in when you’re calculating how much to put into your pension each year.
Unlike an ISA, you can still contribute as much as you want beyond the tax-free allowance. You can also carry forward any unused allowance from the previous three years.
It’s also worth noting that if your pension reaches more than the pension lifetime allowance of £1,073,100, you may be subject to a tax charge. This figure is subject to change year on year.
5. What is the tax-free allowance for a GIA?
GIAs are not designed with tax breaks in mind, any income you earn from them is subject to tax. That’s why investors often use up all their tax-free ISA allowance investments first. Once you’ve reached your ISA limit for the tax year then a GIA is a good way to invest beyond that, though your GIA returns may then be subject to tax.
Tax year end deadlines:
You must make sure you have made the most of your tax-free allowances before April 5th. For the 2020/21 tax year end the last working day is April 1st so this is the date you should be working towards.
If you have a Nutmeg account you can check all of our payment deadlines, extended working hours and other key dates here.
If you miss the tax deadline, you’ll have missed out on the opportunity to maximise your tax-free allowance and won’t have made the most of your investment potential.
Unlike the self-assessment tax deadline, you won’t get a fine from HMRC. However, your investments may be subject to tax if they’re over the tax-free thresholds – having gone into a taxable GIA rather than an ISA.
I’m still not sure about tax year end?
Whether you’re an experienced investor or just looking to begin your investment journey, Nutmeg can help guide you through the end of the tax year and any other questions you might have.
Nutmeg is offering a special offer of no portfolio management fees for 6 months for Emma users.
To take advantage of this offer, start by entering your email address on our partner page. You’ll then be able to see the sorts of returns associated with each type of Nutmeg investment, with a sample portfolio. Terms and conditions apply.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Tax treatment depends on your individual circumstances and may be subject to change in the future.
A stocks and shares ISA may not be right for everyone and tax rules may change in the future. A stocks and shares ISA may not be right for everyone and tax rules may change in the future. If you are unsure if an ISA is the right choice for you, please seek financial advice.
To open a Nutmeg JISA, your child must be under the age of 16 and funds cannot be withdrawn until your child turns 18. Tax treatments depend on your individual circumstances and may be subject to change in the future. If you are unsure if a Junior ISA is the right choice for you and your child, please seek financial advice.
A pension may not be right for everyone and tax rules may change in the future. If you are unsure if a pension is right for you, please seek financial advice.
A stocks and shares Lifetime ISA may not be right for everyone and tax rules may change in the future. You must be 18–39 years old to open one. If you need to withdraw the money before you’re 60, and it’s not for the purchase of a first home up to £450,000, or a terminal illness, you’ll pay a 25% government penalty. So you may get back less than you put in. Compared to a pension, the Lifetime ISA is treated differently for tax purposes. You may be better off contributing to a pension. If you choose to opt out of your workplace pension to pay into a Lifetime ISA, you may lose the benefits of the employer-matched contributions. If you are unsure if a Lifetime ISA is the right choice for you, please seek financial advice.
A general investment account may not be right for everyone and tax rules may change in the future. If you are unsure if it is the right choice for you, please seek financial advice.