Accumulating wealth is one thing; holding onto and expanding it is quite another. Unchecked taxes have the potential to significantly reduce your wealth. A well-thought-out investment strategy and a clever tax plan are equally crucial in the UK, where the maximum income tax rate is currently 45%.
While the best course of action will vary depending on specific circumstances, high earners can take a number of steps discussed in this article to reduce their present and future tax obligations.
Tax planning is an important part of financial planning. It involves maximizing the use of all available tax breaks and deductions to reduce your overall tax burden, ultimately helping to preserve your wealth.
By managing your finances in the most tax-efficient manner, the benefits are twofold: you can reduce your tax liability and retain more of your hard-earned capital, whilst also maximizing the potential return from your investments.
The tax year ends on April 5th, when tax allowances are refreshed and unused tax allowances are lost. The end of one tax year and the start of another provide an opportunity to make your capital work harder and reduce the amount you pay in tax.
The UK tax system can be complex and tax planning can involve a variety of strategies, such as using ISAs, other tax-efficient investment schemes such as the EIS and SEIS, and pension contributions. It’s important to stay updated on the latest tax changes and tax allowances to ensure that you are taking full advantage of all the available options.
A reminder of some of the main direct taxes in the UK at present, and their respective rates and thresholds, may be useful:
- Income tax: Levied between 0% and 45%, depending on your income. Also payable on savings, dividends and interest.
- Capital gains tax: Charged between 10% and 28% on investment gains if the annual threshold (£6,000, as of the 2023/24 tax year) is exceeded. Also payable when you sell a second property and certain possessions worth more than £6,000. It’s worth noting that the capital gains tax annual threshold is reducing from April 2024.
- Inheritance tax: Paid at 40% at the time of your passing on any part of your estate exceeding £325,000.
Ideally, tax planning should be carried out on an ongoing basis, but it is especially important to review your tax planning at the beginning of each calendar year to ensure your financial affairs are organised before the end of the tax year in the UK – the 5th of April.
Planning your taxes in advance of this date can help you to identify any potential tax savings and ensure that you are taking advantage of all available reliefs and allowances. It can be useful to conduct a final review in March, prior to the tax year-end, and ensure your self-assessment is accurate.
It’s important that you don’t let the tax year pass without taking action. Most tax allowances work on a ‘use it or lose it’ basis. If you don’t make use of your tax allowances in this tax year, they are completely lost.
The following list offers a more detailed overview of ten potential ways to reduce your tax bill in the UK:
1. Maintain your income tax allowance
Every individual has a personal income tax allowance of £12,570. Any income received within this allowance will be income tax-free. It’s important to note that income isn’t solely classed as the earnings from your main employment, but also includes pension income, rental income, interest on savings and some redundancy payments.
If you earn over £100,000, including any bonuses, you will lose your personal allowance, either partially or fully, as it works according to a system of taper relief. It is possible to reclaim your personal allowance and avoid tax on your bonus by paying it into your pension.
2. Utilise any marriage tax allowances
If you are married or in a civil partnership, you can transfer up to 10% of your personal income tax allowance to your spouse or civil partner. This is just one of the four main ways that married couples can reduce their tax bill (alongside inheritance tax benefits, capital gains tax benefits and favorable pension rules).
For a couple to benefit from income tax relief, the lower earner must normally have an income below the personal allowance (£12,570) and their spouse/civil partner must have an income below the higher rate tax threshold (£50,271). Transferring the personal allowance can save you up to £250 in tax annually.
It is also possible to backdate your application by up to three years (offering a potential £750 income tax saving).
3. Use your personal savings allowance
Most people can receive some interest on savings, tax-free.
- For non or basic-rate income taxpayers, up to £1,000 per year in savings interest is tax-free
- For higher-rate taxpayers, this allowance is £500 per year
- For additional-rate taxpayers, any interest earned on savings is taxable
Additionally, if you hold savings jointly with your spouse or partner, you can combine your allowances, potentially taking the total tax-free amount to a maximum of £2,000.
4. Utilise ISA contributions
An ISA is a wrapper that can hold assets, usually cash or stocks and shares, and enable any returns to be received free of income tax, capital gains tax and dividends tax.
Read Also: How to do a Tax Return for a Company?
Everybody has an ISA allowance of £20,000 per year, which can be distributed across multiple ISAs (such as a Stocks and Shares ISA, Innovative Finance ISA, Cash ISA and Lifetime ISA) or allocated into one single ISA.
Using your ISA allowance to invest in stocks and shares can protect your assets against dividends tax and capital gains tax, and if you exclusively hold AIM shares within your ISA, it could also become free of inheritance tax after two years.
5. Consider the dividends allowance
All individuals in the UK are entitled to receive up to £1,000 per year of dividends, tax-free (previously £2,000 in 2022/23). This can be useful to be aware of if you own shares in dividend-paying stocks or are a company director.
However, as announced in the Chancellor’s 2022 Autumn Statement, this allowance is set to halve once again to £500 as of the 2024/25 tax year. This means that individuals who rely on dividends as a form of income could pay considerably higher figures in annual dividends tax should they be retained and no tax-efficient investment route applied.
6. Make use of annual pension contributions
Up to the age of 75, you can contribute up to £40,000 a year (or 100% of your annual earnings, if this figure is £40,000 or less) into a pension. However, there are some restrictions for high earners, in the form of the tapered pension annual allowance.
Funds held inside a pension can grow free from income tax and capital gains tax, and upon the pension holder’s passing, are generally not subject to inheritance tax.
Furthermore, if you’re a business owner, the company can make pension contributions on your behalf, which acts as a deductible business expense against corporation tax.
On top of your regular pension annual allowance, you can carry forward your pension allowance from the previous three tax years – this is one of the rare allowances that isn’t lost each tax year.
This means that you can potentially make a contribution of up to £160,000 (£40,000 from the current year and £40,000 from each of the previous three tax years) into your pension. However, the rules surrounding this can be complicated and it’s useful to seek professional advice when planning your pension.
7. Understand the capital gains tax allowance
If you make a financial gain on an investment (outside of an ISA and other types of tax-efficient schemes), an additional property, or a possession worth £6,000 or more (excluding your car) you may be liable to pay capital gains tax (CGT).
Everyone in the UK is entitled to a capital gains tax allowance of £6,000 per year. This figure has more than halved from 2022/23’s figure of £12,300 and is set to halve further to £3,000 in the 2024/25 tax year.
The rates of CGT in the UK as of the 2023/24 tax year differ depending on which income tax band you fall into. For higher and additional rate taxpayers, the CGT rate currently stands at 28% on residential property and 20% on any other chargeable assets. For basic rate income taxpayers, capital gains tax of 18% would be due on residential property and 10% on any other chargeable assets.
Importantly, you can transfer your assets to your spouse or civil partner, free of capital gains tax, and they can subsequently make the gain. This can be particularly useful if you pay a higher rate of income tax than your partner.
You can also sell taxable investments and reinvest them tax-efficiently. For example, you could sell an investment and reinvest the proceeds in an Innovative Finance ISA (IFISA) or Stocks and Shares ISA. This could use your capital gains tax allowance and ensure that any gains in the future are CGT-free.
If you have made gains above the annual capital gains tax allowance, you may want to consider other HMRC-approved tax-efficient investment wrappers, such as EIS- and SEIS-eligible investments. Investing in EIS- and SEIS-qualifying investments enables you to defer, and potentially fully negate, capital gains tax bills, as well as maximize income tax and inheritance tax efficiency.
8. Maximise the advantages of EIS investments
For higher earners or business owners who are higher-rate taxpayers in the UK, Enterprise Investment Scheme (EIS) investments can be a useful way to reduce your tax liability. This is because investments made through the EIS can be eligible for a variety of tax reliefs, such as income tax relief, capital gains tax deferral and exemption, and inheritance tax relief.
By investing in EIS-eligible companies (which tend to be early-stage startups and scaleups), you can claim up to 30% income tax relief on the value of your investment, ultimately reducing the amount of income tax you owe and minimizing some of the financial risk associated with the investment.
Additionally, any capital gains made on the investment can be deferred until the investor decides to dispose of the EIS-eligible investment. This can provide considerable tax savings for high-net-worth individuals and business owners who are looking to reduce their tax liability.
Some important points about the EIS and the respective tax reliefs are noted below:
- Maximum contribution per annum: £1 million (or £2 million, provided that additional capital is invested into knowledge-intensive companies [KICs])
- Income tax relief: up to 30% of the value of your EIS investment
- Capital gains tax disposal relief: EIS shares are capital gains tax-free upon disposal, provided they have been held for at least three years
- Capital gains tax deferral relief: CGT due on other assets can be deferred if the associated capital gain is invested into EIS-qualifying shares
- Inheritance tax relief: receive100% IHT relief on the value of EIS shares, provided that they have been held for a minimum of two years and are still held at the time of the investor’s passing
The Seed Enterprise Investment Scheme (SEIS) is the UK Government’s more recent variation of the EIS. Focusing on particularly early-stage startups, the SEIS offers a comparatively more generous range of tax reliefs for investors due to the additional risk considerations associated with seed-stage companies.
Importantly, the Chancellor announced that the SEIS would undergo some changes in the 2023/24 tax year, making the eligibility criteria for later-stage startups to access the scheme more inclusive and the maximum annual investor allowances more generous:
- The maximum amount a company can raise via the SEIS is set to increase by £100,000 (from £150,000 to £250,000)
- Companies can still qualify for the SEIS even if they hold up to £350,000 in assets (up from £200,000) and have traded for up to 3 years (as opposed to 2 years)
- The annual SEIS investment allowance for investors has doubled, from £100,000 to £200,000
The collection of tax reliefs offered by the SEIS are comparatively more generous than those offered by the EIS:
- Maximum contribution per annum: £200,000, as of the 2023/24 tax year
- Income tax relief: up to 50% of the value of your investment
- Capital gains tax disposal relief: SEIS shares are capital gains tax-free upon disposal, provided they have been held for at least three years
- Capital gains tax reinvestment relief: claim up to 50% capital gains tax relief on any on other asset, provided that the gain is reinvested into SEIS shares
- Inheritance tax relief: receive 100% IHT relief on the value of SEIS shares, provided they have been held for a minimum of two years and are still held at the time of the investor’s passing
10. Explore VCT investments
Venture Capital Trusts (VCTs) invest in a portfolio of unlisted early-stage companies, providing capital to small private British businesses with the aim of generating high returns for investors. The VCT itself is often traded publicly.
You can contribute up to £200,000 per year to Venture Capital Trusts, and the main benefit of investing in a VCT is that you can receive income tax relief of 30% on the capital you invest. Any dividends can be received free of tax and there is no capital gains tax to pay on any profits, as long as you have held the investment for at least five years.
In the end, there are some difficult aspects of the UK tax system. Consequently, one of the most crucial methods to protect your wealth is to implement a sophisticated tax planning approach. A thoughtful plan put into action at a strategic juncture during the tax year can help you drastically lower your tax liability. Furthermore, you can avoid paying taxes on your money and increase the potential for further wealth growth by combining tax-efficient investment wrappers with competent tax planning.