Emily Pool asks, “Are You Paying Too Much Tax?”

£32,550 is the magic number.The magic number for what, you ask? This is the amount of earnings and investment returns that can be made by most UK tax paying individuals before incurring a tax charge in the current tax year (2019/20).

So let’s break this magic number down, and see how these allowances can be used to mitigate your tax bill:

Personal Allowance for Income Tax

All UK resident persons who have total taxable income of less than £100,000 have a Personal Income Tax allowance of £12,500. Those with taxable income in excess of £100,000 lose £1 of the allowance for every £2 they receive over this threshold. Once income exceeds £125,000 the allowance is nil.

Starting Rate of Tax at 0%

Those earning less than £17,500 also have an additional allowance for Savings Incomeof up to £5,000. Those earning £12,500 or less get the full £5,000. If earned income is more than £17,500 there is no Starting Rate for Savings (and you just receive the normal Savings Allowance (see below). If your other taxable income is between £12,500 and £17,500 the amount of savings subject to the Starting Rate of 0% is reduced by £1 for every £1 your other income exceeds £12,500.

Capital Gains Tax (CGT) Allowance

You have to pay CGTon the profits of sale of most personal possessions worth £6,000 or more( apart from your car) and on property that’s not your main home. In the current tax year, the CGT Allowance is £12,000. This allows the profits from the selling of assets (including investments not held within ISAs) to be sheltered (or partially sheltered) from paying CGT of 10% (where the profit falls within the Basic Rate tax band) or 20% (where falling in the Higher or Additional Rate tax bands).

Each UK tax payer has this allowance and therefore married couples will have two. Investments and assets should be spread across both husband and wife to make full use of both allowances where appropriate. Transfers between spouses and donations to charities are CGT free.

Dividend Allowance

You can receive up to £2,000per year in dividends before tax is levied at 7.5% (basic), 32.5% (Higher) and 38.1% (Additional). This is relevant to equity investments held outside of tax wrappers such as pensions and ISAs.

Savings Allowance

As a Basic Rate Tax payer you can receive up to £1,000per year in interest from savings i.e. bank deposits, UK bonds (government and corporate), and other lending-type products before tax is levied at your marginal rate. This allowance falls to £500a year for Higher Rate Taxpayers and is withdrawn for Additional Rate Taxpayers.

So there you have your breakdown of the £32,500 annual allowances that can be used towards earnings, savings and investment income. But there is more…

Side-Line Tax Allowances

You can rent a room in your house and receive the first £7,500rent tax-free under the “Rent a Room” scheme. Also, the first £1,000 of income from short term lets and AirBnB type arrangements or letting of land is also tax free, but you can’t claim this if you are claiming under the Rent a Room scheme.Joint landlords will each have an allowance meaning the total joint allowances are £15,000 and £2,000 respectively.

How about taking advantage of the Digital Economy and doing some online trading. Your first £1,000profit from self-employmentwill also be tax free. Come on, dust off that eBay account and get selling!

ISA Allowance

If you have spare cash on deposit (after allowing for an emergency fund of around 6 months’ expenses), which is likely earning little or no interest, consider investing it in a Stocks & Shares Individual SavingsAccount – or an ISA to give it its high street name. UK taxpayers can invest £20,000 each year in a variety of different ISAs, with the advantage of allowing income and capital growth to accumulate in a tax efficient environment within the ISA tax wrapper, and withdrawals are also tax-free. Gains made in ISAs do not count towards the dividend and savings allowances mentioned above, and should therefore be seen as a complimentary investment strategy to direct equity or bond investment.

A particularly attractive type of ISA for younger savers is the Lifetime ISA(or LISA), which you can use to buy your first home (if under £450,000) or save for later life. You must be between 18 and 40 to open a LISA.You can save up to £4,000 each year until you’re 50, and this will count towards your £20,000 annual ISA allowance. HMRC will add a 25% bonus to your savings, up to a maximum of £1,000 per year. You can make tax free withdrawals in the following circumstances: 1) to purchase a property; 2) when you reach 60; or 3) when diagnosed with a Terminal Illness. If you withdraw for any other reason a 25% charge will be levied.

Children have their own Junior ISAallowance of £4,368a year. Like normal ISAs this can be invested in Cash or in Stocks and Shares (or a combination of both). Parents or guardians with parental responsibility can open a Junior ISA and manage the account, but the money belongs to the child, who can take control of the account when they’re 16, but cannot withdraw the money until they turn 18.

Please remember that investing in a stocks and shares ISA carries risk. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

Pension Annual Allowance

Individuals may contribute up to the amount of their annual gross annual earningsor £40,000, whichever lower. This limit includes both employer and employee contributions.  Unused annual allowance from the previous 3 years can also be carried forward.

Making pension contributions is an excellent idea for many reasons, the most obvious being that you are making provision for your future when you are no longer able to work. The State Pension was never designed to fully provide for you in retirement. I know Financial Advisers who refer to it as the “Wine Allowance”, and for most of us who are still young enough to save into our pensions, that’s a healthy way of looking at it. The full New State Pension (SP) is currently £8,767.20, but an individual’s entitlement will depend on their National Insurance contribution history, and the age it becomes payable is on the rise. Today’s 40-year old will have a State Pension Age of 68 – both men and women. Gone are the days when women received SP at 60 and men at 65. So contributing to a pension is vital if you hope for a retirement lifestyle better than breadline.

But the advantages don’t end there. Employers pension contributions can be made from gross pay (i.e. tax free). And HMRC will provide an 20% tax credit to all UK taxpayers’ pension contributions. If you are a Higher or Additional Rate Tax Payer you can also make a claim in your annual Self-Assessment tax return for a further rebate. For example, a higher rate taxpayer can contribute £8,000 from net pay, which HMRC would gross up to £10,000 and then could claim a further 20% back meaning the contribution cost them only £6,000.

A third reason for pension contributions, which not many people will know, is that they can be used to lower your income that is taken into account when being assessed for the High Income Child Benefit Charge, which is a claw back of the Child Benefit paid to individuals earning £50,000 or more. For example, if you earnt £60,000, and made a contribution of £8,000, which would be grossed up to £10,000, lowering your net adjusted income to £50,000, you would avoid this clawback – which would be worth £1,789 per year for a family with two children. Also, if your income is above £100,000 you start to lose your Personal Allowance (£1 for every £2 earnt over £100,000), but this can be mitigated if you use pension contributions to reduce your adjusted income to the £100,000 threshold amount.

Don’t be afraid of Pensions. They are just investments with a tax-efficient wrapper. As with all investments they should be considered long term, which means starting early and allowing compounding of income and growth to build gradually over time.

A pension is a long-term investment which is not normally accessible until you reach 55 years of age. As with any investment, the fund value may fluctuate and the investment and income from it can go down, which would have an impact on the level of pension benefits available.

Oh, and one more thing, you don’t pay tax on Premium Bond and National Lottery wins, but rather than rely on these I suggest you try to make use of some of the other allowances, which are more within your control!

Personal taxation is a complex area and if you would like to discuss any of the above with a Financial Adviser, please do not hesitate to give me a call on 07786 854048.

For further information on income tax please refer to the HMRC website: https://www.gov.uk/government/publications/rates-and-allowances-income-tax/income-tax-rates-and-allowances-current-and-past

Please remember, no news or research item is a recommendation or advice to buy. This does not constitute individual tax advice and should not be relied upon as advice. All information is based on 2019/20 tax years. Tax rates and allowances may change in the future and should tax planning be required individual advice should be sought. The Financial Conduct Authority does not regulate tax advice. If you are unsure of the suitability of any investment or product for your circumstances please contact an adviser.