Three tax breaks you can carry forward and three you can’t

How often have you seen the words “use it, or lose it” in articles about tax planning? Come the end of the tax year, the message is clear, take advantage of your tax allowances before 6 April, otherwise they will be gone for good.

But while that’s certainly true in a number of cases, it isn’t always so. The UK tax system can be fiendishly confusing, and there are a handful of occasions where that “annual allowance” is a little more flexible than it initially appears.

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Get into the nitty-gritty with three tax breaks you can carry forward into the new tax year and three you definitely can’t.

What you can carry forward

1) Your pension allowance

Each year you can pay 100% of your income, up to a maximum of £60,000, into your pension and get your contributions boosted by tax relief, equivalent to the rate of income tax that you pay. But, if you have the means to do so, you may be permitted to pay in even more and still get the government top-up.

Carry-forward rules allow you to also use any pension allowance that you didn’t use in the previous three tax years. This means that the maximum you could potentially pay into your pension and get tax relief this year is £200,000 (two years where the pension allowance was £40,000 and, after an increase on 6 April 2023, two at £60,000, including the current tax year).

To be eligible though, you need to have had a pension in any year that you are carrying forward and you also need to have earned at least the amount you are paying in, during the current tax year.

These rules are pretty prescriptive, but they can come in handy for higher earners with a fluctuating income, or those who have received a windfall that they would like to pay into a pension.

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They can also be helpful if you are a high earner stung by the tapered annual allowance. This gradually starts reducing your pension allowance once you have an adjusted income (your total income as well as the value of your employer pension contributions) over £260,000. This could potentially reduce the highest earners’ pension allowances to a low of just £10,000. However, by taking advantage of carry-forward rules they may be able to pay in more.

It’s also important to be aware that you lose the right to carry forward unused pension allowance once you have made a taxable withdrawal from your pension and triggered the lower money purchase annual allowance (MPAA), currently £10,000.

2) Your inheritance tax gifting allowance

Charged at a rate of 40% on assets above a certain threshold, inheritance tax (IHT) can take a serious chunk out of the amount you leave to loved ones.

If you have an IHT liability bubbling away, giving away wealth before you die can be a straightforward way to reduce the bill.

Typically, cash gifts are considered “potentially exempt transfers” – this means that they will be subject to a reducing rate of IHT over time, only becoming totally tax free if you live for seven years. However, it is possible to make some gifts that are automatically free of IHT.

Each year the gifting allowance lets you give away £3,000 tax free. Even better, this is another allowance that isn’t quite use it or lose it. While you can’t carry forward unused allowance indefinitely, you can use any allowance you didn’t use in the last tax year.

This means that, if you didn’t use your gifting allowance last year, you can actually give away up to £6,000 this tax year. Or if you are in a couple, up to £12,000 between you.

3) Capital losses

You might want to quickly forget money you have lost on an investment, but it makes sense to keep a record of them and report them to HMRC. They could end up doing you a favour further down the line.

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Although the capital gains tax (CGT) allowance cannot be carried forward, you can carry forward investment losses and offset them against capital gains to reduce your tax bill.

So, if you have a bad year and make more losses than gains, you can report them and use them to offset capital gains in future years. Don’t worry if you haven’t reported losses from previous years, HMRC gives you four years to report a loss.

‘Use it or lose it’ allowances

1) Capital gains tax allowance

Your CGT allowance, or annual exempt amount, is the gains you can realise each year tax-free. The allowance has shrunk dramatically over the last two years from a high of £12,300 to just £3,000.

This means more ordinary investors will be affected. Take the example of someone who has enjoyed moderate gains on a shareholding of £500 a year. After 10 years they have a £5,000 gain and decide to sell. Once the £3,000 exempt amount is deducted they would have to pay CGT on £2,000 of their gain.

Even though their annual gains have been well below the CGT allowance, you only get the opportunity to take advantage of this tax break when you come to sell, so over the 10-year investment, the annual allowance is only being used once.

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However, this could have been avoided by taking advantage of the annual allowance each year, by selling a portion of the shareholding to realise a gain. So long as each sale didn’t exceed the annual exempt amount, gains could have been managed and no CGT would have been payable.

Selling investments to take advantage of the CGT allowance doesn’t have to mean you come out of the market when you might not want to. The 30-day rule may stop you buying the same investment back straightaway, but you can still reinvest your gain in something similar or take the opportunity to diversify your portfolio.

2) The dividend allowance

Investors don’t just pay tax on capital gains - dividends are taxable too. And just like gains it’s another allowance that has been subject to savage cuts, currently standing at just £500 a year.

The tax is charged at a rate of 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for those that pay the additional rate.

Married couples might be able to avoid paying tax on dividends by transferring assets between each other and making sure you are using both sets of allowances. Transferring assets between spouses can also be helpful if one of you pays less tax.

However, the best way to shelter your dividends from tax is to make the most of both your ISA and pension allowances where your money can be left to grow tax free.

3) Your ISA allowance

Money held in individual savings accounts (ISA) is totally sheltered from tax. There will no tax charged on interest or dividends, nor will there be any tax to pay when you take money out.

This means it really does make sense to make the most of your £20,000 ISA allowance each year. Although you can’t carry forward any unused ISA allowance, bear in mind that married couples can effectively join forces and shelter £40,000 a year between them.

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And, if you’ve maxed out your ISA and still have money to spare, you can pay into a child’s or grandchild’s Junior ISA on their behalf – they have a £9,000 allowance each year.

It’s also worth knowing that if you have money in a general investment account (GIA), that could be subject to tax, you can sell holdings and immediately buy them back within a stocks and shares ISA using Bed & ISA rules (without worrying about the 30-day rule). You just need to ensure you have enough ISA allowance remaining for the year and be mindful not trigger a CGT bill by selling gains that would breach your annual exempt amount.