Tax efficiency is something we all aspire to, but this is often a complex area that too few of us really understand and can get to grips with. Laws and thresholds appear to change with some regularity and, as we enter into a new financial year, more changes have been made to taxation thresholds especially for higher earners.
Tax changes as of 6 April 2011
Thresholds at which the higher tax rate of 40% kicks in will be lowered from £37,401 to £35,001. This figure signifies earnings over and above personal allowances.
It’s also worth noting that personal allowances have also been raised from £6,475 to £7,475 and, as announced in the recent Budget, the personal allowance will also rise again in 2012 by £630 to £8,105.
Implications
Figures from the Institute of Fiscal Studies suggest that more than three-quarters of a million more people will unwittingly find themselves sitting in the higher-rate tax bracket of 40% from 6 April.
A report in the Daily Telegraph also suggested that an extra 120,000 people paying the top rate of 50% tax will increase over the next five years, because the threshold at which it is paid (£150,000) will not increase in line with inflation.
Consumer awareness
According to a survey compiled by HSBC, in excess of 80% of Brits are in the dark regarding the changes to personal tax and cash ISA allowances, with a distinct lack of awareness noted among low income earners.
The survey of 2,000 British adults showed that 47% believe that it is always compulsory to pay tax on your savings. Furthermore, 82% are unaware that the cash ISA allowance is being increased from £5,100 to £5,340 on 6 April, 2011.
Offsetting the tax implications
Aside from these not-so-unsurprising revelations, help could be at hand for a good proportion of the work force though the tax efficiency attached to an offset mortgage.
Offset is still, quite rightly, heralded as the most tax-efficient product on the market and helping clients to find the most efficient way for managing all their finances holistically will be key to success in 2011.
Despite initially being perceived as a product only for wealthy clientele, the popularity of offset has risen amongst remortgagers, contractors and the growing legion of self-employed people who have long been advocates of offset.
Generally speaking offset mortgages remain suitable for the following:
-Anyone who has 5% of their mortgage balance in savings
– Self-employed people who can ring-fence the money for their tax bills into the offset arrangement
-People who invest money in Individual Savings Accounts (ISAs) can offset the ISA money to the mortgage
– Higher rate tax payers
One of the main selling points of an offset mortgage is its tax-saving potential. Higher rate taxpayers would normally see 40% of any interest on their savings accounts swallowed up in tax, but because they receive no interest on savings linked to offset mortgages, they have no tax to pay. This element provides substantial benefit to such clients fitting this profile.
Benefits include…
Benefits for higher tax rate payers
Taxpayers falling into the 50% tax bracket should definitely consider getting an offset mortgage to beat the effects of tax and inflation and help mitigate negative returns on their savings.
This is especially evident with the base rate currently residing at a historic low of 0.5% and a retail price index of 5.5% as both of these are having a massive impact on the economy and savings rates in particular.
For example, a borrower remortgaging onto a £275,000 offset loan for 25 years from Woolwich at 3.09% and holding £50,000 in a linked savings account, would only pay interest on the remaining £225,000.
This would save them £16,705 in interest over the lifespan of the mortgage and knock three years off the payment term.
To match this deal, savers in the 50% tax band would need to find a savings rate of at least 5.76%. With offset, this type of borrower not only has instant access to their savings to spend as and when they desire, but it also provides a good equivalent rate of return, making it an attractive option.
For taxpayers falling into the 20% to 40% bracket, offsetting can still be very much worth it.
The benefits of offsetting as outlined remain and, to compare, a 20% taxpayer would need to find a savings interest rate of above 3.60% and a 40% taxpayer 4.80%. Such rates, I suspect, will remain a challenge to find for some time to come, unless these savings are tied into a long-term fund which will not allow instant access unlike the savings linked to an offset mortgage.
The ever-increasing number of self-employed people can also reap the benefits of offset due to the likelihood of them setting a certain amount of funds aside each month in order to cover National Insurance, income tax and VAT contributions.
These funds could work better for them when linking to offset, rather than funnelling into separate savings accounts.
Benefits for intermediaries
It is not only the client who can benefit from a better financial planning tool; there are also many benefits for you, the adviser.
Such advice can help deepen client relationships and increase loyalty from your client. If the client reaps the full benefit of these potentially large savings, they will quickly become an advocate for your business and a source of referrals which, most importantly, may result in increased sales and income.
It is fair to say that 2011 will be a year focused on remortgage business, as potentially hundreds of thousands of borrowers stand to gain from remortgaging. The challenge for intermediaries who have historically not sold offset is to ensure they offer the best advice to these repeat remortgage customers.
However, now armed with much lower rate options – options that were not available upon taking out the original mortgage – offset can provide the perfect opportunity for clients looking to a truly flexible and tax efficient financial planning tool.
David Finlay is intermediary business director of Barclays
