Lifetime ISA or a pension?
It depends on your age and stage. For those on the lower rate tax and wanting to buy their first home, Lifetime ISAs, or LISAs, are a great deal and also ideal for the self-employed who don’t get employer contributions to a pension scheme. The scheme will be launched on 6 April 2017, but you need to be under 40 on that date to qualify. However, for higher rate taxpayers, pensions are more generous. But they both have pros and cons, so if you can afford to, pay into both to max the free cash from the government. And always stay in your workplace pension or you’ll miss out on contributions from your employer. Also, LISAs could be the first step towards scrapping tax relief on pensions, so top up your pension while you still can. It currently only costs 40% taxpayers £600 for every £1,000 that goes into their pension.
How it works
LISAs – There’s a government bonus of £1 for every £4 saved before the age of 50. You cannot access the cash until the age of 60 (if you want to take it out before then, you forfeit the bonus and also pay a 5% penalty), unless you are using the money to buy a first home (see below). When you take the money out, it’s tax free. The investment limit is £4,000 per year, and will be part of the new £20,000 annual ISA limit.
Pensions – You get tax relief when you pay in up to a limit of £40,000 per year, so it’s particularly valuable for higher rate taxpayers. When you withdraw money, which is allowed from the age of 55, the first 25% is tax free; after that, it’s taxed.
What about help to buy ISAs?
If you have not yet bought a home and want some free cash from the government to boost your deposit, these are worth having now. They are open to all ages (not just those under 40), and you can start saving in them until the LISA is launched next year – and simply transfer the money (and bonus) across. The LISA government bonus is far higher (a maximum of £32,000 compared with just £3,000 in a Help to Buy ISA), and you can contribute much more – £4,000 a year compared with just £200 a month in a Help to Buy ISA, plus a £1,200 initial cash sum.
Help to Buy ISAs will be withdrawn from December 2019, although you can add in money until 2029 – and use the bonus to buy a property until 2030. If you qualify and are setting up a LISA as well, you can only get one bonus to buy a home, so you might want to transfer your Right to Buy ISA across. For both LISAs and Help to Buy ISAs, you must never have owned a property or inherited one, both here or outside the UK, and the property you buy can only be worth up to £250,000, or £450,000 in London.
Do any ISAs have a good return?
Savings rates are at an all-time low but new peer-to-peer (P2P) – or Innovative Finance (IF) ISAs – give a better return, though with a higher risk. These work by lending your cash to lots of people (as little as £10 per person), who are credit checked and risk assessed. Interest rates can pay up to 7%; as this is a tax-free ISA, you keep it all. You can also transfer old ISA money into these new ISAs, so cash getting 1% in cash ISAs can now earn a decent return.
You could lose money if borrowers default. Also, P2P loans aren’t covered by the Financial Services Compensation scheme; this protects up to £75,000 in banks and building societies. To cut the risk, opt for a fixed-rate product such as Zopa’s 4.5% Classic Account, which is covered by its own Safeguard fund. As you can only put your £15,240 ISA allowance into one new IF ISA each tax year, choose different providers when transferring your cash ISAs to spread the risk. Details at zopa.com, fundingcircle.com and ratesetter.com
What about any new tax breaks on savings?
From April 2016, everyone can earn up to £1,000 of savings interest and £5,000 of dividend income free of income tax. It makes saving more worthwhile, as some of the best savings rates are outside tax-free ISAs – such as the Nationwide bank account paying 5% interest (balances up to £2,500 for the first 12 months), the TSB Classic Plus account paying 5% (balances up to £2,000), or 3% (balances up to £20,000) on Santander’s 123 account. Always be aware of the terms and conditions.
Forty per cent taxpayers can only make £500 of savings interest free of tax, and 45% taxpayers nothing at all. Also, they have to keep track of interest/dividend payments and include them on their tax return. It’s worth considering saving and investing through an ISA to cut the hassle (ISAs aren’t included on tax returns).
Good news for small traders
You can soon earn up to £1,000 tax free selling things online or from your home, which is good news if you run a small eBay or Etsy business, for example. The same applies to providing a service such as cooking for dinner parties, gardening, or any other goods and services you sell as a little business.
If you rent out a room on sites like Airbnb, you can make £1,000 a year tax free, in addition to the £7,500 you can earn from renting a room.
Also, you don’t pay tax on anything you sell on sites like Gumtree if you are just selling things you no longer need. If, however, you are “trading” – buying and selling goods – technically, you need to pay tax.
The new tax break doesn’t come into effect until April 2016. Also, you have to track all your income (and costs). If you make more than £1,000, you’ll be able to simply deduct the first £1,000 from your income to benefit from the allowance. But you will need to file a tax return. Register as self-employed at hmrc.gov.uk
Who will benefit from the capital gains tax cut?
From the start of this tax year (6 April), you can now make £11,100 of capital gains (basically, profits when you sell assets) without paying tax, and the rate of tax on anything above this has been cut dramatically to just 10%, down from 18%, for basic rate taxpayers and 20%, down from 28%, for those paying 40% tax. Note that the sale of private cars and antiques under £6,000 are already exempt from capital gains tax.
The new rules do not apply to second homes or buy-to-let properties. The capital gains tax rate on these is 18% for basic rate taxpayers and 28% for higher rate taxpayers. Capital gains tax rules are complicated so if you own stocks and shares, keep them in an ISA – that way, you’ll be protected from future tax changes too.
Note: This feature contains a correction from the magazine where we wrongly published that the date the allowance comes into force was April 2017.