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Broadly speaking, you can increase your disposable income in two main ways: spending more and earning more. The latter, however, can be achieved not only via pay rises, but also using tax-efficient planning. In this guide, our team at Cedar House shares four ideas to help people reduce an income tax bill legitimately – especially for higher earners. We hope you find this content useful. If you want to discuss your own financial plan with us, please contact our team for more information or to access personalised financial advice:
020 8366 4400 or enquiries@cedarhfs.co.uk
#1 Increase pension contributions
Your pension is a valuable financial planning tool – not just to help boost your retirement fund in the future, but also to potentially save on tax in the shorter term. In 2021-22, you can put up to £40,000 into your pension(s) each tax year or up to 100% of your earnings (whichever is lower). Any contributions then receive tax relief equivalent to your highest rate of income tax. So, for a Basic Rate taxpayer it only “costs” 80p to put £1 into a pension (20% relief). For someone on the Higher Rate, however, it only costs 60p (i.e. 40% relief).
Here, you can be quite smart with your contributions. For instance, suppose you earn £70,000 per year. This means that £12,570 will be tax-free, as this falls within the Personal Allowance. Then, £37,430 will be subject to the 20% Basic Rate. Anything above £50,000 will be subject to the 40% Higher Rate; in this case, £20,000. However, suppose you put this amount straight into your pension (assuming you can afford it). This would save you £4,000 in tax now, and the UK government would put this amount straight into your pension.
Of course, you need to bear in mind the potential downsides of doing this. In particular, you will not be able to access the funds in your pension(s) until age 55 (rising to 57 in the future). Also, be careful to check how the tax relief is claimed. Some pension schemes operate on a “net pay” basis, whilst other use “relief at source”.
#2 Charitable giving
You can give to charity free of income tax – provided this is done via gift aid, or directly from your pension or wage (i.e. under “payroll giving”).
For instance, suppose you are a Basic Rate taxpayer and make a £200 donation using gift aid. Here, HMRC regards the donation as £240. The recipient charity can then claim the £40 held back by the government.
In light of this, make sure that your existing donations are being made via one of these methods. Not only does it help your donation go further towards a good cause, but it could help out more back into your own pocket.
For Higher Rate taxpayers and Additional Rate taxpayers, you can gain an extra 20% and 25% relief, respectively. However, this needs to be disclosed on your self assessment tax return.
#3 Tax code review
Millions of UK taxpayers overpay every year due to placement on the incorrect tax code. This is especially common for those on “Emergency Tax”, which HMRC often does when it does not have enough information about you and your income and tax details. Perhaps you recently got a new job (in PAYE employment) and have not been issued your P45 yet. Or, maybe you just started getting your State Pension.
Check your most recent payslip for the following codes:
- 1100L W1
- 1100L M1
- 1100L X
- BR (20% tax)
- 0T (40% tax)
If you see these then you are on Emergency Tax, which may mean you are being overtaxed. Here, you can send your new employer your last P45 or details of your previous income and tax payments. They can then update your details with HMRC.
If you have been incorrectly taxed, make sure you chase the government about it. They will not typically go out of their way to correct things for you.
#4 The Marriage Allowance
If you are married and your spouse is not working – or earns less than their £12,570 personal allowance – then he/she can pass up to £1,260 of unused allowance to you. This can help your household cut its income tax by up to £252 per year. This is also available to civil partners.
For this to work, however, the spouse passing over the allowance must not pay tax. Also, the receiving spouse must be a Basic Rate taxpayer. This can be especially helpful for families where one person has taken time off work to care for the children.
Bear in mind that any unclaimed allowance over the last five tax years can be claimed for. So, make sure you check whether you are entitled. In some cases (e.g. where a spouse has taken a long career break to raise children), a rebate over £1,250 may be available.
Conclusion
Interested in discussing your financial plan with an experienced financial adviser? Get in touch today to discuss your financial plan with a member of our team here at Cedar House via a free, no-commitment consultation:
020 8366 4400 or enquiries@cedarhfs.co.uk