When the end of the financial year approaches in March, it’s always good to review what you can do to reduce your tax bill when the return is due – and use up what allowances you have for the year as well, before they expire. These are our suggestions for ways you can look at reducing your tax bill and making the most of your allowances.
To begin with, we’ll look at the different tax rates and how they are structured.
Income tax rates and levels
This is the tax you pay on all the income you have, usually from employment. It can range from 0% to 45%, and the rate goes up with your earnings. Everyone in the UK has a tax-free (0%) on the first £12,570 that they earn, whether that’s from salary, benefits, rental income, interest or pensions (until you reach an income of £100,00, anyway – more of that later).
Over the amount of £12,570, you pay the 20%Basic Rate tax on the remainder. So if you earn £22,570 for the year, you’ll only pay 20% tax on the £10,000 over and above your tax-free allowance – not on the full £22,570.
The next rate jump is for the Higher Rate when your income is over £50,271, when any amountearned above this is taxed at 40%. Beyond that, the Additional Rate threshold kicks in at £150,000, which taxes any amount over that at 45%.
The 60% “tax trap”
If you earn over £100,000, your tax-free personal allowance is reduced by 50% – so for every £2 you earn over £100,000, your allowance is reduced by £1 – so if you earn £ 125,140, your personal allowance amount is £0 – and you’ll be paying National Insurance on top of that too, effectively meaning you are taxed at 60% instead of 40%.
Paying less tax (reducing your liability)
You are not able to pay less tax than the amounts set out above – however, you can effectively reduce the amount of income that is used in your tax calculation. This is particularly useful for that “tax trap”, and those whose incomes are just above any particular threshold.
Pension contributions
The most common and straightforward way to reduce the amount of income that is included in your tax calculation this is to pay into a pension, as that amount is deducted before your tax liability is calculated. You can do this via salary sacrifice with your employer, or by paying into a private pension, or both – although it’s worth noting that the private pension contributions will need to be entered on your tax return for the year to enable the correct calculations, whereas the salary sacrifice route will calculate your tax at the point you are paid.
Example: if you earn £60,000, you would normally be liable to pay tax at the basic rate and at the higher rate, because your income is over the Higher Rate level of £50,271. However, if you pay £10,000 into a pension, this reduces your taxable income to £50,000 – below that Higher Rate level of 40%, meaning you will pay £4000 less tax and still keep and invest the money you’ve earned for your future.
If you’re using private pension contributions, be aware that there is a maximum amount that you can pay in every year – currently £40,000 – however you can carry forward any previous years’ allowances that you haven’t used fully.
Charitable donations
You’re probably aware of the Gift Aid benefits out there – when you give money to a charity, the government effectively “refunds” the equivalent basic rate of tax you would have paid on the amount to the charity – but if you are a Higher or Additional Rate tax payer, you can also deduct the amounts you’ve paid on your self-assessment return. So if you’ve made a gift of £100, and the charity have claimed the 25% in Gift Aid, you will be entitled to claim £25 back on the total £125 received by the charity (this rises to £31.25 for Additional Rate payers).
Tax relief schemes
The government has created investment schemes to benefit small and medium businesses, which are funded by donations. In exchange for donations, you can receive significant tax relief of between 30% and 50% – however, because of the type of business they support, these schemes are seen as high risk investments.
What Next?
Speaking to a financial advisor is the step to take when considering your tax liabilities, and the options open to you.
NB: The value of investments, and any income from them, can fall and you may get back less than you invested.