How to reduce the amount of personal tax you pay in the UK.
How to reduce the amount of personal tax you pay in the UK.
Introduction.
Whatever your stance on how the Government spends the tax it collects, there is more to paying personal taxes than just what is paid via PAYE. Equally, it is crucial to understand the difference between tax avoidance and tax evasion – the former is simply applying the rules set by HMRC to make sure you are not paying any more tax than you are required to, the latter being the illegal act of deliberately avoiding paying taxes owed by underreporting income, inflating deductions, or hiding money in unreported accounts.
This article will equip you with practical knowledge about the avenues outlined by HMRC that you can explore to ensure you are not paying any more tax than required.
The arguments for and against taxation.
If you have spent more than a few minutes following financial topics on social media, you will know that an argument always seems to break out whenever public spending or taxation topics crop up. On one side, you have those who believe the answer to fixing our creaking public services is to generate more tax revenue, and on the other side, you have those who think they pay too much tax already and it is poorly spent.
Five reasons why taxpayers may want to increase taxation in the UK:
Income redistribution: To reduce income inequality by redistributing wealth from higher earners to lower-income individuals through social welfare programmes.
Public services funding: To increase funding for essential public services such as healthcare, education, and infrastructure, ensuring better quality and accessibility.
Debt reduction: To help reduce national debt and budget deficits, promoting long-term economic stability.
Social justice: To ensure that those who have a greater ability to pay contribute more to the collective wellbeing of society, fostering a sense of fairness and solidarity.
Investment in future growth: To finance investments in areas like renewable energy, technology, and research, driving sustainable economic growth and job creation.
Five reasons why taxpayers in the UK may not want to pay any more tax than they already do:
Perceived fairness: Higher earners may feel that they already contribute a significant portion of their income and that further increases would be unfair and punitive.
Economic incentives: Higher taxes might reduce the incentive to work harder or invest, potentially stifling economic growth and innovation.
Efficiency of government spending: Concerns that the additional tax revenue may need to be spent more efficiently and effectively, leading to waste rather than tangible benefits.
Personal financial impact: Higher taxes can reduce disposable income, impacting lifestyle choices, savings, and investments for middle—to higher-earners.
Competitive disadvantage: High taxation rates might make the UK less attractive for top talent and businesses, leading to a potential brain drain or relocation of companies to more tax-friendly countries.
The importance of tax planning.
Regardless of which side of the fence you sit, tax planning is essential to effective financial management. As such, taxpayers should take advantage of the opportunities available to minimise (or defer) their tax liabilities.
Effective tax planning not only helps ease your current tax burden but can also play a significant role in helping you achieve your long-term financial goals. As always, the earlier you start planning, the better positioned you are to make the most of available tax reliefs and allowances.
Some notes before we begin…
The tax-reduction steps outlined below are very vanilla. It is common for many people to think that financial success means complicated offshore trusts and high-risk dynamic investments, which may be true for the very wealthy. However, for the vast majority of taxpayers in the UK, financial success often means using a regular income to build a balanced investment portfolio and retirement fund and making that money go as far as possible in the future. Remember, consulting with a financial adviser can provide reassurance about your compliance and tax efficiency.
Step 1: Think about your money as pre-tax and post-tax.
Reducing the amount of tax you pay means getting the most out of it BEFORE and AFTER you pay tax. For most of the working population, the gross money you earn in your pay packet is before tax, and the net money you receive in your bank account is after tax (things may change a little if you are self-employed or draw your income from investments). With this distinction in mind, you must make the most of your money in both scenarios.
Step 2: Think about the tax treatment of savings and investments.
Everywhere we hold money in the UK attracts specific tax rules. Before doing anything, you should consider what the tax is on the way in and what the tax is on the way out.
For example, employee contributions into a workplace pension from your gross salary are tax-free on the way in, but you will pay tax when you take the money out when you retire (subject to any tax-free lump sum rules at the time). Whereas the money you pay from your net salary into an ISA has already been taxed, and any gains you make with the money are tax-free.
Bank cash savings accounts are an example of where you put taxed money aside, and once the low threshold for tax-free savings interest has been breached, the gains you make are then taxed again. In this case, you are paying tax on the money twice: once when you earn it and then every year on the gains you make above a threshold, which is obviously something to consider.
How to make the most of your pre-tax gross salary.
Making the most of your pre-tax salary is vital for all taxpayers, and it is even more critical for additional and higher-rate taxpayers as HMRC helps themselves to a healthy percentage of your earnings.
As such, you may want to consider some of your pre-tax options for your salary, including:
Maximise your employer pension contributions, as this really is free money! They help your employer reduce their corporation tax bill and help you build a retirement fund. However, as with most pensions, there may be some tax to pay when you access your pension in the future.
Maximise your employee pension contributions as HMRC will give you tax relief on what you pay in.
See if Salary Sacrifice could work for you. Not all employers offer a salary sacrifice scheme, but they generally provide a way for you to pay for nursery fees, bikes, gym membership, technology products, electric vehicles and more from your pre-tax salary.
Consider Share-Save schemes, if offered. They offer a way for you to buy shares in the company with pre-tax salary.
Another alternative is to Save As You Earn (SAYE), a savings plan for pre-tax income.
Payroll giving is a way to give pre-tax income to a charity of your choice, which has a tangible benefit, rather than your tax just going into the pot with everything else.
This list is not exhaustive. However, it gives you an idea of what you can do to reduce the tax you pay, particularly if you work for a larger employer.
For those who own their businesses or are self-employed, there are other options available to you, including:
Drawing a low salary and the rest in dividends from profits, if the dividend tax-rate is lower than the income tax rate (speak to your accountant for more details).
Make sure you utilise all the expensing allowances stipulated by HMRC. This may be a small amount of money, but every little helps.
Make the most of your family's Personal Allowances, as everyone is entitled to an amount of income earned each year without paying tax.
Marriage Allowance is also worth considering as you may be eligible to transfer a portion of your personal allowance to your spouse or partner, provided they are a basic rate taxpayer.
How to make the most of your post-tax net salary.
OK, you have made the most of your pre-tax income. Now, you have your net earnings in your bank account and want to be as tax-efficient as possible. Here are some ideas to consider:
Ensure you fully utilise your Personal Savings Allowance, as you can earn a certain amount of tax-free interest on your savings each year.
Make more pension contributions into a SIPP or similar, as you can claim tax relief on these for a near-instant return at the rate of tax you pay. This is useful for helping you build those vital retirement savings. If you haven't used your full pension allowance in previous years, you may be able to carry forward unused allowances from up to three previous tax years, allowing you to make larger contributions in the current year.
If you have excess cash, consider paying money into Premium Bonds. It won't earn interest, but any prizes you will receive are tax-free and could be a life-changing sum. This is a valuable home for your emergency fund.
Pay money into an ISA. ISAs come in various flavours, including Cash ISAs and Stocks & Shares ISAs (plus a few other obscure varieties). In simple terms, a Cash ISA is a tax-free savings account, and a Stocks & Shares ISA is a tax-free investment account – all the capital gains you make and income you draw from it will be totally tax-free. There are annual contribution limits, so keep an eye out for them. However, it is possible to build a seven-figure sum, which would be an excellent source of tax-free income for retirement. Also, you can access the money, which is not locked away.
If you hold investments outside of an ISA, you can use your Dividend Allowance and Capital Gains Tax Allowance (whilst they still exist) to earn dividends and profits from investments up to a specific limit without paying tax. You can then reinvest the profits from these investments into an ISA to shelter the future profits from tax.
Consider transferring assets to your spouse or civil partner. This strategy can help use both partners' capital gains tax allowances and potentially reduce the tax rate applied to gains.
Make the most of Gift-Aid, particularly if you are a higher-rate taxpayer.
One of the most effective ways to reduce Inheritance Tax (IHT) is through Potentially Exempt Transfers (PETs). PETs are gifts made during your lifetime that may be exempt from IHT if you live for seven years after making the gift.
Conclusion.
So there you have it—a few examples of how to think about tax and some fairly basic ideas for how you can reduce your personal tax liability right now. None of it is going to set the world on fire; however, it is all very mainstream, and there is something in there for every taxpayer to do.
Effective tax planning involves making the most of your pre-tax and post-tax income alongside understanding and utilising the available allowances and reliefs. By strategically managing your savings, investments, and contributions, you can significantly reduce your tax burden and enhance your financial wellbeing. Regularly reviewing your financial situation and consulting with a financial adviser can ensure you stay compliant and maximise your tax efficiency.
What’s next?
If you need assistance with your personal finances, particularly in the context of Capital Gains Tax, our advisers are here to help. You can get in touch with one of our advisors for independent financial advice and we offer a free initial consultation. Based in Royal Tunbridge Wells, we advise clients across the UK.
Don’t forget, this article offers general financial information and should not be taken as personal advice. Remember that investments and pensions can go up and down in value, so you could get back less than you put in. Tax rules can change and will depend on your individual circumstances.