Have you ever wondered how much tax you actually pay?
With Personal Allowances currently frozen at £12,570 in the UK until 2028, we're all silently getting poorer 😤.
More and more people will want to keep more of their hard-earned money each month.
Paying tax is of course, important.
However, there are certain government schemes that reward you from a tax perspective when you defer gratification, save and invest more for future events like retirement, etc.
Today we're going to look at different legal ways that you can reduce your taxes in the UK.
This is not a guide on how to evade taxes because that's completely illegal.
Everything I'm sharing today are things that you can find publicly on the government's website.
7 Ways To Reduce Your Tax Legally In The UK
Let's look at these 7 ways to reduce your tax legally.
1. Invest More Into ISAs
Saving and investing in an ISA (Individual Savings Account) is more important now than ever before.
Investments outside of an ISA or a pension are under attack.
The capital gains tax-free allowance (currently £12,300 per year) is being cut to £6,000 in April 2023, then being cut to £3,000 in April 2024.
This means that the more of your £20,000 ISA allowance you use up, the better.
There was also recent research by the Resolution Foundation recommending that the ISA should be capped at £100,000 tax-free as a lifetime limit.
All this points to ISAs potentially coming under fire at some point in the not-too-distant future.
So you should use up as much of your ISA allowance as you can or lose it.
Everything that you save and invest into an ISA is free from tax (income tax and capital gains tax), including any gains that you generate.
This is great because not only does it give you tax-free growth, but you also get 25% bonus contributions by putting money into a Lifetime ISA.
Alternatively, you can use a LISA to save for retirement.
If you use up the £4,000 annual allowance, it still leaves you with up to £16,000 to save into other ISAs e.g. Stocks and Shares ISA.
To learn more about the pros and cons of the Lifetime ISA, see our detailed video below:
2. Contribute More To Pensions
You can either contribute to your pension as an employee or as somebody who owns a business or a bit of both.
Reduce Your Tax As An Employee
Pensions naturally attract tax relief.
So if you're a basic rate taxpayer, if you put £80 into a pension, as an example, you get £20 back again.
If you're a higher taxpayer, for example, and contribute £80, you'd get £40 back, and so on for additional rate taxpayers.
So you can see that it's definitely in your interest to put money into a pension.
You also expect to get 25% of your pension pot as a tax-free lump in the future, and then the rest gets taxed at your prevailing tax rate.
You can also contribute to a pension even if you're not working.
For anyone who has the means and who has a partner, you can put money into your partner's pension, and they will get tax relief up to £3,600 per year.
You would need to put £2,880 in and the government will top it up by £720.
Recommended: Watch our complete guide to pensions in the UK below:
Reduce Your Tax As A Business Owner
You can now contribute up to £60,000 a year from your business or side hustle into your personal pension.
This would usually be a tax-deductible expense for your business.
The fact that you're making an income from your salary does not count towards that because you've contributed that straight from your business.
In addition to that, you can backdate your pension contributions provided a pension scheme has been in place.
You can go as far back as three years and can usually get up to £40,000 per year.
Although I'm speaking to a very small group of people who have the means with this point, I hope that having the knowledge can serve as an aspiration for others for the future.
3. Marriage Allowance
This is only relevant to those married or in a civil partnership.
There are over 2 million people in the UK right now who qualify for this marriage allowance, but who are currently not claiming it yet.
The marriage allowance allows a spouse who is not using up all their personal allowances to allocate 10% of it to their husband or wife or civil partner.
To qualify for this, you need to meet these conditions:
- You're married or in a civil partnership,
- You don't pay tax or you earn below the Personal Allowance, currently £12,570,
- Your partner pays the basic rate of tax or earns below £50,270.
If you meet these conditions, you save £252 a year i.e. £12,570 x 10% = £1257.
Then, 20% of that will give you £251.40.
Although it might not sound like a lot, every little helps in the current economic climate.
4. Salary Sacrifice
This is where the government allows you to give up a portion of your salary to be spent on things such as your pension, a bike-to-work scheme, etc.
There are big advantages when it comes to using salary sacrifice, which your employer has to offer, for your pension purposes.
The first advantage is that you pay less National Insurance and so does your employer i.e. they pay less Employers' National Insurance Contributions (NIC).
Recommended: Here is a detailed video on how salary sacrifice works:
The reason why you pay less National Insurance is because you're being taxed on a lower taxable income.
When salary sacrifice your gross income, it goes straight into your pension. So the amount subject to taxes is, therefore, smaller.
That smaller gross amount is subject to taxes and results in less national insurance and tax and so on.
One of the most standout reasons for doing salary sacrifice is for those people who are earning in the middle income, for example, anyone earning just over £50k.
At that stage of income, it starts to affect your child benefit, i.e government benefits that you can claim for your children.
Example: Let's say you earn £55,000.
If you salary sacrifice £5,000 it brings you down below that £50,270 higher rate tax band.
Doing this will help you to receive the full Child Benefit, which can be worth quite a lot for families.
Example: Let's say you earn £130,000.
The other advantage to salary sacrifice is for people who are earning over £100,000, for example.
From 6th April 2023, If you're earning £125,000 and above, you'll become subject to the additional rate of tax at 45%.
By salary sacrificing some of your gross income, not only do you have more of that money going into your pensions, you also bring yourself back into the 40% tax bracket from 45%.
People who earn over £100,000, start to lose some of their personal allowances.
They lose £1 for every £2 above £100,000.
So for anybody who earns around £125,000, they lose 100% of their personal allowances.
The more you salary sacrifice some of your gross salary into a pension, the more you recover some of your personal allowances.
This is huge if you think about it.
Now I know the big restriction is that you might have gotten yourself accustomed to a particular lifestyle.
So readjusting your life such that you bring down your lifestyle a little bit, can be quite hard for some people because they are already maxing out on their lifestyles.
This is something to work out for yourself.
If you can do it, you might find that earning £99k might even be better for you compared to earning £125k.
It gets even more powerful if your employer is also matching your pension contribution.
5. Sharing Assets
This spousal exemption means that assets that produce income, for example, can be shared between spouses without actually triggering a tax bill.
By doing this, you can max out on all your allowances. So here, I'm talking about your
- Income tax allowances
- Capital gains tax allowance
- Dividends allowances
- Savings allowances
With our personal allowances being frozen and with capital gains and dividend allowances being slashed, now is the time to make the most of these.
Have that discussion with your partner (if you have one) and max out on all your allowances.
6. Gifting Assets
The sixth way in which you can reduce your tax bill is through gifting.
Here I'm specifically speaking to inheritance tax.
There's a 7-year rule when it comes to inheritance tax.
If you gift an asset to somebody and you remain alive after 7 years of gifting that asset, that asset falls outside of what's known as your estate, for inheritance tax purposes.
You have to keep records and things like that to document that you have gifted this asset at a particular time.
But this helps massively because inheritance tax is levied at a rate of 40% on any gifts you give 3 years before death.
Note that the seven-year rule is on a sliding scale. It's on what's known as a taper relief scale.
Number of years between gift and death:
- Less than 3 years (40% tax is paid)
- 3 to 4 years (32% tax is paid)
- 4 to 5 years (24% tax is paid)
- 5 to 6 years (16% tax is paid)
- 6 to 7 years (8% tax is paid)
- 7 or more years (0% tax is paid)
Inheritance tax is levied on estates above the tax-free or nil rate band, which is £325,000.
This amount can also be increased to £500,000 if you're passing on a home.
There's also an annual £3000 exemption for gifts. So that's also something worth mentioning.
But there's a lot to talk about here when it comes to inheritance tax.
Recommended: Inheritance Tax: How Should You Prepare?
7. Invest In Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS)
Venture Capital Trusts (VCTs) are companies that offer investors tax breaks, such as a 30% income tax rebate on the amount invested.
In addition, you also get tax-free dividends.
VCTs continue to be extremely popular, especially for the mass affluent i.e. those who can easily invest £20k to £30k in such investments.
However, note that VCTs are very risky!
You also have to hold your shares for 5 years to get the full tax benefits.
If you want to invest in a VCT, I'd highly suggest focusing on a high-quality VCT with an established track record.
In addition to VCTs, you can also consider Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS).
These offer up to 30% and 50% income tax reliefs respectively, as well as capital gains tax exemption.
Again, these are government-backed and offer tax breaks for investments in small, high-risk companies.
This naturally, won't be for everyone, so please do your research well before investing.
8. Move Abroad
This is a bonus point and a bit of a wildcard.
In all honesty, if I was in my 20s and had to do life again, I'd seriously consider moving abroad for a few years.
I'd do it primarily for the experience and secondly, the opportunity to build wealth more quickly.
Would you do it? Or have you done it? 🤔. Comment below.
I've got friends who have taken a leap.
They've gone to the Middle East (Dubai, Qatar), Portugal, and St Lucia, for example.
It would appear that they have more favourable tax situations going on over there, plus you don't have to move permanently.
In fact, I was on holiday once and I bumped into a couple who were both teachers in the UK.
Their game plan was to move to teach in the Middle East, raise some money, build up their deposit, and then move back to the UK and buy their own property.
With an ever more connected and digital world, it is becoming normal to work in one country and live in another.
Paying tax is very important as I mentioned earlier.
However, it's very important to also look after your finances and use up as many government allowances as you can because wealth building in the next few years will be harder.
In all this, keep your eyes on your goals whilst doing what brings you joy today.
Stay positive and practical.
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I'd love to hear from you guys in the comments. Is moving to another country as a way to start a new life, reduce your tax or build some wealth something you would consider? Comment below.