2020/21: An unusual tax year
Pat Nown reviews important tax year-end considerations to review for the 2020/21 tax year.
February can often be an unsettling month because the feeling of euphoria of completing the final self-assessment returns is short lived as the realisation kicks in that there are only a few weeks remaining before another tax year ends and a new one begins.
For individuals, the impact of COVID-19 will unquestionably have a significant effect on reportable income for many in 2020/21 and may continue to impact for some time, so it is important that certain routine tax year-end considerations attract sufficient review.
Two such areas are:
- Pension tax savings decisions and
- The High Income Child Benefit Charge
Pension tax savings decisions
Pension contributions are tax effective in the tax year in which made, so many clients make decisions towards the end of the tax year depending on expected tax rates and levels of income. For example, they may top up pension contributions to obtain higher rate relief. With many experiencing a reduction in income in 2020/21, measures may need to be taken to adjust the level of additional contributions downwards to retain the optimum position.
A reduced income level could provide an unusual opportunity however for those aged 55 and over. The small pension pot rules allow a pot which has a value of £10,000 or less to be cashed in.
Take a taxpayer who normally pays tax at higher rate but due to furlough or redundancy in 2020/21 has basic rate capacity of £6,000 and a small pension pot worth £8,000. To cash this in the cost would normally be £2,400 (£8,000 x 25% = £2,000 tax free and £6,000 x 40% = £2,400).
If this was cashed in whilst the taxpayer has basic rate capacity, then there is a saving of £1,200 (£6,000 x 20% = £1,200) and therefore a net cash inflow for the tax year of £6,800. (£8,000- £1,200 = £6,800). For further details on small pension pot rules see here.
Non-taxpayers can also benefit from making pension contributions.
Earnings are not required to qualify for tax relief on personal pension contributions of up to £3,600 (gross) per annum. In practical terms, £2,880 can be paid into a qualifying pension scheme, which, with the addition of £720 basic rate tax relief, creates a pension investment of £3,600.
This can provide a pension pot for non-working spouses or other family members. It can also be considered for someone with profits from a property investment business, which are not generally classed as earnings.
The High Income Child Benefit Charge (HICBC)
Child Benefit is clawed back through the HICBC where either partner of a couple has adjusted net income over £50,000 during the tax year. When income is above £60,000, all Child Benefit payment is lost.
Normally the year end planning tactic is to review whether there is any opportunity to keep the income of each parent below £50,000 to keep full payment. This may for example involve capping dividend extraction or paying additional pension contributions.
For 2020/21, a fall in income could mean the charge is reduced or eliminated.
What if the couple have not received Child Benefit because normally one of them has income of more than £60,000 but a fall in income means they are now entitled?
If they have previously been registered but elected not to receive the benefit, then they need to revoke the election so it can be restored retrospectively for the tax year. If they have not previously registered, then they can make a claim, but it can only be backdated three months.