In 1798 William Pitt the Younger, in his December Budget, announced the birth of income tax.
The then-prime minister established the tax, which came into force the following year, to fund the war against Napoleon.
In the 225 years since, the UK tax system has become significantly more complex and much more lucrative for the government. Total UK annual receipts are forecast to surge past £1 trillion in the next few years.
What’s more, due to something called fiscal drag – where frozen tax thresholds trip more people into higher tax brackets – our personal tax bills are only going one way. By 2027-28, 14% of adults are expected to pay higher rates of tax; in 1991-92 the figure was just 3.5%.
It’s therefore key to explore ways to shield your hard-earned wealth from HMRC’s clutches. Here are six tax-planning tips for you to consider before 5 April.
1) Trim your income tax bill with pensions
Income tax is the biggest source of revenue for the government, generating around £250 billion a year.
Anyone who earns more than £12,570 this year will almost certainly pay income tax, and if you’re under state pension age, currently 66, you’ll pay national insurance too.
And the more you get paid, the more tax you will pay. Anything you earn between £50,270 and £125,140 will be hit with 40% income tax, while anything above is taxed at 45%.
But an effective tool to prune your income tax bill is to make pension contributions, and it’s particularly powerful for those in the upper tax brackets.
If you pay 40% tax, every £100 you pay into a pension (within certain limits) effectively costs you £60, or just £55 if you’re in the 45% threshold. What’s more, as your pension pot grows, you won’t pay tax on any gains and income.
But there is something you must be aware of. Unless your pension payments are deducted from PAYE under a net pay arrangement - where your employer deducts pension contributions from your pay before it's taxed; or through salary sacrifice, where you trade part of your salary for a pension payment - you must remember to claim the extra tax back via self-assessment.
Hundreds of thousands of people fail to do this every year and miss out on what is effectively free money. According to new poll* from us here at ii, a third of higher rate taxpayers could be losing out thousands of pounds in pension tax relief.
For example, if you’re a 40% taxpayer and pay £8,000 into your ii self-invested personal pension (SIPP), you get an immediate £2,000 boost from the government in the form of tax relief at source, and you can claim back an extra £2,000 through your tax return.
2) Max out your ISA if you can
Protecting your investment portfolio from the taxman can make a marked difference to how quickly your money grows.
Individual savings accounts (ISAs) are a great way to shield any gains, dividends, and interest from the taxman. And with most ISAs you can get your hands on the money whenever you like without penalty.
The maximum you can save and invest into ISAs every year is £20,000. So for couples this figure doubles to £40,000 – a healthy sum.
It’s important to be aware that some ISA allowances aren’t quite as generous. The Lifetime ISA, which can be used to fund a deposit on a first home or save for retirement, has a maximum annual figure of £4,000 – but comes with a 25% bonus on what you pay in. Any contributions to a Lifetime ISA form part of your £20,000 allowance.
Meanwhile, the Junior ISA has an annual limit of £9,000. However, this is in addition to your own ISA allowance.
3) Use your CGT allowance to Bed & ISA
If you have investments held outside tax wrappers, you should strongly consider using your annual capital gains tax (CGT) exemption by 5 April.
The CGT allowance halved from £12,000 to £6,000 in the 2023-24 tax year and will halve again to £3,000 from April.
The drawback here is that any gains you realise above this figure outside of tax wrappers could be subject to heftier tax bills. A higher-rate taxpayer who makes a £10,000 profit selling shares will pay an extra £600 in CGT in the next tax year.
It’s therefore wise to consider using the bigger allowance while you still can. A useful trick to protect any future growth from CGT is to sell gains up to your allowance and reinvest them into your Stocks and Shares ISA – a process known as “Bed & ISA”.
This is, of course, dependent on having some spare ISA allowance for the current tax year. If you don’t, then it can still make sense to use the CGT exemption before April and top up your ISA in the 2024-25 tax year when your £20,000 allowance resets.
4) Get immediate relief from IHT
In most cases, when you make gifts to save inheritance tax (IHT), which has a heavy top rate of 40%, you must survive seven years before the money or asset moves outside your estate. But there are ways to trim your IHT bill immediately.
One useful tactic is to make “gifts out of normal expenditure”. Simply put, you have carte blanche to do whatever you want with your income, which includes handing it to other people.
You just need to prove that any gifts won’t affect your current standard of living. HMRC states “you should consider what is current income and expenditure on an annual basis using the accounting year to 5 April”.
- ‘Tis the season…to cut your inheritance tax bill
- Estate planning: do you have your admin under control?
So, if you have an IHT problem that you’re seeking to mitigate, and this option is available to you, it makes sense to calculate how much you can give away between now and April.
In addition, you can also give away £3,000 a year, called your “annual exemption” and can hook £3,000 from the previous tax year if unused; this means couples could gift £12,000 now immediately to reduce their heirs’ IHT bill.
5) Make the most of your personal savings allowance(s)
Even if you’ve maxed out your ISA allowance for 2023-24, there are still ways to save tax on your cash savings.
The personal savings allowance enables you to earn a certain amount of interest every year and not pay tax. However, the size of your allowance depends on how much you earn.
If you pay 20% tax, your savings allowance is £1,000.
Higher-rate taxpayers have an allowance of £500, while 45% taxpayers don’t get one – you pay tax on all your savings.
- HMRC tax raid hits savers: tips to protect your income
- What happens to my investment portfolio when I die?
Given the top instant-access accounts currently offer around 5%, a basic-rate taxpayer could start paying income tax once savings exceed £20,000. This figure drops to around £10,000 for 40% taxpayers.
To keep as much of your income as possible, if you’re married or in civil partnership think about how you can manoeuvre your savings to make the most of your combined allowances.
For instance, if one of you pays 40% tax and the other 20%, consider holding enough in the 40% taxpayer’s name to stay within the £500 a year cap and shift the remaining savings to the 20% taxpayer. Not only will this give rise to a bigger allowance but means anything above will be taxed at 20% instead of 40%.
6) Top up your pension to retain valuable benefits and allowances
If you have young children or earn a big salary, pension contributions can bring additional financial perks.
Child benefit is a valuable income source for many parents, but if one of you earns more than £50,000 a year, then it may reduce and could even be lost.
That’s because for every £100 you earn above £50,000, you’re hit with a 1% charge on child benefit payments. By this calculation, once earnings hit £60,000, child benefit is completely wiped out. For a family with two children, the lost sum equates to £2,075 a year.
Likewise, for every £2 you earn above £100,000 a year, your personal income tax allowance reduces by £1. So, your allowance disappears once income hits £125,140.
- If you have two minutes…10 pension ‘quickies’
- Day in the life of a pension fund manager: Invesco’s Matthew Henly
The combination of 40% income tax and lost child benefit or personal allowance, creates an effective tax rate of 60% on this portion of your income.
There is, however, a solution.
In both above scenarios, as paying into a pension reduces your “adjusted net income” you can get both tax relief at your marginal rate and retain the above-mentioned valuable allowances and benefits.
For example, if you earn £57,000, making a net £5,600 contribution to your ii SIPP (which is grossed up to £7,000 due to 20% tax relief at source), your net adjusted income for the year would fall to £50,000.
The benefits here are three-fold: you swerve the High-Income Child Benefit Charge, you can claim back an extra £1,346 (£7,000 - £6,730 x 20%) on your tax return, and your retirement savings get a healthy boost.
I explain in greater detail how pensions can help keep your personal income tax allowance in this article.
*Poll was conducted on interactive investor website on 3 and 4 January with 1,063 respondents.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.