Here comes the taxman

Will Chancellor of the Exchequer’s spring budget contain some unpleasant surprises? Rishi Sunak is due to unveil his budget on 3 March and is widely rumoured to be looking for opportunities to increase the amount of tax flowing into the Treasury’s coffers.

That is understandable, given the battering taken by the public finances during the Covid-19 pandemic. But it could spell trouble for savers and investors putting money by for the future. The tax breaks on pension contributions are one possible target for the Chancellor, but there are other avenues he could explore.

Trying to second-guess budget measures is a fool’s errand. And even if you are good at crystal-ball gazing, making investment decisions purely for tax reasons very rarely makes sense. Nevertheless, for anyone thinking about their savings over the course of the rest of the tax year – which ends on 5 April – keeping one eye on what the Chancellor is up to is probably a good idea.

Where the axe might fall…

Successive governments have sought to encourage different forms of savings by offering generous tax breaks to those who put money by. The most obvious example is pension saving, where you get tax relief at your highest marginal rate on contributions; a £1,000 pension contribution, say, costs basic-rate and higher-rate taxpayers only £800 and £600 respectively. That applies on a pretty generous annual allowance – up to £40,000 each tax year for most people.

Individual savings accounts (Isas) are also an attractive proposition. Each year, they allow you to make up to £20,000 worth of savings or investments in a very wide range of assets. Inside the Isa, any income or profit you earn on these assets is completely free of tax.

Venture capital trusts (VCTs) are another good example. These allow savers to invest up to £200,000 a year in specialist funds that back younger and smaller companies. In return for the extra risk posed by such businesses, savers get 30% upfront tax relief, plus all future income and profit is tax-free.

In theory, the Chancellor might target any or all of these schemes in his March budget. Pensions are an obvious candidate because the cost of all that tax relief is very high, though making changes is politically different. It seems less likely that Isas will be in the firing line, though successive governments have made various tweaks to the VCT rules over the years.

…and how you should prepare

Again, it is important not to let the tax tail wag the investment dog, as the old adage goes. But if the Chancellor does decide to make changes to tax-efficient savings schemes, it is a good idea, if possible, to make full use of them while you can. In most cases, budget reforms will not come into effect until the beginning of the 2021-22 tax year on 6 April, so you will have some time to respond. Use it before you lose it, you might say.

In truth, this is good advice in any case. Most tax breaks on savings – including on pensions, Isas and VCTs – are an annual opportunity. Any tax relief you don’t claim in a particular tax year is gone for good (there are exceptions to this rule for pensions). So, at this time of year, it is good housekeeping to look at whether you have scope to increase your savings to take advantage of the various reliefs available.

Always keep in mind that it is the underlying investment that will deliver most of the return you earn over the long term, not the tax break. That makes it crucial to think hard about how you use your pension and Isa allowances. The strong performance track record of investment companies gives them a good claim to a place in your portfolio, but think about your attitude to risk, your investment objectives, and where new investments fit into what you already hold.

Similarly, there are now quite a number of VCTs competing for your 2020-21 tax year allowance. Many of the managers offering VCTs have an excellent long-term track record, but choose carefully – and take independent financial advice if you need more support.