How a financial adviser would start the new tax year

It’s important to get your finances in shape to start the new tax year with a bang.

Two of our expert financial advisers reveal the key things to think about when starting the new tax year.

This article isn’t personal advice. Pension and tax rules can change, and benefits depend on your circumstances. Different tax rates and bands apply for Scottish taxpayers. If you’re not sure what to do, please ask for financial advice.

Make use of your ISA and pension allowances

In lots of ways ISAs are the easiest and simplest way of saving money. This tax year you can add up to £20,000 to an ISA. Once it’s in there, you won’t have to pay UK income or capital gains tax. You don’t even have to fill in a tax return.

It makes sense to use your ISA allowance as soon as possible as the sooner the money is in an ISA, the sooner it’s free from UK income and capital gains tax. It also means it then has more time to grow. If investing in an ISA, like a Stocks and Shares ISA, isn’t right for your financial goals, you can still use other ISAs to save tax, like a Cash ISA.

Remember unlike cash which is guaranteed, all investments can rise as well as fall in value so you might not get back what you invest.

How early should you use your ISA allowance?

Adding money to a pension, like a SIPP, helps you save for retirement and it can also reduce your tax bill. It’s a win-win.

Remember money in a pension can't normally be taken out until 55 (57 from 2028), when up to 25% is usually tax free with the rest taxable.

If you’re a UK resident, under 75, the general rule is you can contribute as much as you earn to pensions each tax year and receive tax relief. This is usually capped at £40,000 a year, but anyone who earns over this might be able to make use of the carry forward rule and add more. Your allowance might be less than £40,000 if you earn over a certain amount or have previously accessed benefits from a pension.

Annual allowance – what you need to know

With the freeze on income tax thresholds, more people are likely to end up paying more in income tax by 2026. By making pension contributions from your income, it could mean you slip back under a threshold and pay less tax. As with ISAs, you don’t have to pay UK income tax or capital gains tax within a pension.

Did you know: Pensions don’t usually count towards your estate for inheritance tax purposes. So contributing to a pension could be a tax efficient way to pass on money to loved ones.

Utilise the power of regular saving

Investing on a monthly basis is one of the most powerful ways of building wealth. It’s all down to ‘pound cost averaging’.

Drip-feeding into the stock market could mean the average price you pay for your investments ends up being lower than a single lump sum investment. Investors average out the price of buying investments and benefit from a phenomenon known as pound cost averaging.

This means your investment buys more units or shares when the price goes down, helping you smooth out the returns from investing in the stock market. However, investors should remember that if the market rises above the original price, fewer units are bought.

Use the start of a new tax year to get into better savings habits.

It’s important to plan your regular savings ahead of time, especially if you’ll be using a tax wrapper like an ISA or SIPP. The best time to plan is at the beginning of the tax year. That way you can calculate how much of the allowance your monthly contribution will use up.

For example, £500 every month into an ISA will use £6,000 of your £20,000 ISA allowance in 2021/22. This means you have £14,000 remaining allowance to use before 5 April 2022.

Review the risk in your portfolio

Risk sounds scary, but you can find a level you’re comfortable with by diversifying and using the right mix of investments (your asset allocation). The level of risk within a portfolio is often based on your goals and investing time frames, so step one is to nail those down.

It’s important to review this at least once a year. You might need to adjust your portfolio more often than this if there have been changes in your circumstances or goals.

If you’re an HL client, you can review if you’re using the right mix of investments by using the ‘Portfolio Analysis’ tool on the ‘My Account’ screen when you’re logged in.

When you’re reviewing your investments, it’s important to think about tax too.

Some investments are taxed differently than others. For example, income from dividends is taxed differently from income from corporate bonds & government bonds (gilts).

This is particularly important if you are or are about to be drawing income from your portfolio.

Each type of investment income has a basic, higher and additional-rate threshold similar to income tax on earned income.

You might also have a personal savings allowance and dividend allowance to offset against some of this income before it becomes taxable.

Please note: the rates a Scottish taxpayer pays on dividends and savings income are determined by the UK bands not the Scottish bands. This also applies to capital gains tax.

Diversification

Holding a mix of different types of investments is just one way to diversify. You can also diversify by sector and geography.

Getting a balance of all those things can be tricky. There’s no magic number for the number of holdings you should have. But it can be a delicate balancing act between holding too many or too few investments.

Read more about diversification

Beware of capital gains tax

Every year, you can grow your wealth without paying capital gains tax (CGT).

The CGT allowance is £12,300 and has been frozen until 2026. Any gain above that falls within the basic-rate tax band which is taxed at 10%. Any part of the gain which falls into the higher- or additional-rate bands is normally taxed at 20%. But higher rates apply to residential property.

One way to use your capital gains tax exemption is by selling investments not sheltered from tax and reinvesting into a more tax efficient account like an ISA or pension. Doing it this way means you don’t pay any capital gains tax on the sale of your investments once they’re in an ISA or pension, and your future investment is sheltered from tax.

Make use of the spousal exemption

If you’re married or in a civil partnership, there are rules around gifting assets. These can be helpful but a little complicated to get your head around.

You don’t normally have to pay CGT on gifts to a spouse and you can divide your assets to make better use of each CGT exemption.

This means couples can have a combined CGT allowance of £24,600 (£12,300 each) and share assets between them without triggering a capital gains tax bill. To help cut your tax bill even more, the assets can be held by or transferred to the spouse paying the lower rate of tax.

Just remember, once an asset is gifted, you can’t normally take it back.

You could also pay less income tax as a couple if gifting brings one of you under a tax threshold without tipping the other over one.

If one spouse is a non-taxpayer, and the other is a basic rate taxpayer, the non-taxpayer can give £1,250 (10%) of their personal allowance to their spouse in the current tax year.

This means the basic rate taxpayer could earn £13,750 before they have to start paying tax, rather than £12,500.

Review your general finances

Sometimes, getting started is the hard bit. But once you’re up and running, it can be easier to find the motivation to get more done. Use this fresh motivation to review other aspects of your finances – your home energy bill, your phone contract or even your car insurance.

If you have a set time each year that you review these things, they become much easier to keep on top of. And what better time to do some financial spring cleaning than the start of a new tax year.