Breathe a sigh of relief this tax year end

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The 2018/19 tax year end is fast approaching, which means now is the time to review your tax position.

Tax planning can be a bit like playing Tetris. You’ve got different blocks of income and investments dropping into view, all at different times throughout the year, and you’ve somehow got to arrange everything so that no gaping holes remain.

To further complicate matters, the rules of the game change with each new tax year. Allowances, reliefs, tapering and thresholds; the goalposts set by HMRC are constantly shifting.

All of this can make optimising your tax position a daunting task.

The good news is, you don’t have to be an accountant to spot the potential tax traps you could be falling into. It could be as simple as moving money from one place to another (from your bank account to your pension, for example). Or, it may be that you’re missing out on so many reliefs and allowances that your situation warrants professional advice.

Either way, there are certain steps you can take to ensure you remain on top of your tax planning. We start by looking at reliefs, specifically pension tax relief.

Working out your liabilities

Tax reliefs are offered by the government to incentivise behaviours that it believes will benefit society as a whole – e.g. saving into a pension, giving to charity, cycling to work and possibly getting married. Therefore, it makes sense to take advantage of them where possible.

Before you can identify the tax reliefs available to you, it’s important to establish where your income sits in relation to tax thresholds.

In the current tax year, the personal tax-free allowance is £11,850

  • The next £34,500 of income is then taxed at 20%, meaning you can earn up to £46,350 gross salary this year and remain a basic rate taxpayer
  • Income above this amount, but below £150,000.01 will be taxed at 40%
  • Beyond £150,000, earnings are taxed at 45%.

Identifying ‘hidden’ tax thresholds

Within these bands however, there are some hidden thresholds to watch out for.

The high income child benefit tax charge

If you receive child benefit, then for every £100 of income earned between £50,000 and £60,000, 1% in child benefit entitlement is clawed back. As it goes on the income of the highest earner in the household and not overall household income, this is especially unfair on high earners whose partners are stay-at-home parents, and high-earning single parents. Two parents earning £49,999 would be entitled to the full child benefit amount, whereas a single parent earning £60,000 wouldn’t be entitled to any of it. HMRC offer this handy calculator to help you work out your position.

The six-figure curse

Next, there’s what The Financial Times refers to as “the six-figure curse”. Once you start earning over £100,000, you begin to lose your tax-free personal allowance. Specifically, for every £2 earned over the threshold, £1 of personal allowance is removed. This creates an effective ‘hidden’ tax band between £100,000 and £123,700, where income is taxed at 60%.

Spotting opportunities for relief

Remember: the greater the tax liability, the greater the potential for tax relief. And the first port of call for anyone seeking tax relief is the pension pot. Putting money into your pension not only attracts tax relief at your highest marginal rate (i.e. higher-rate taxpayers get 40% tax relief on pension contributions), it also alters your net income for tax threshold calculation purposes.

So, let’s say you’re subject to the high income child benefit tax charge because you earn £52,000 per year. If you were to put £1,200 of your after-tax income into your self-invested personal pension (SIPP), then two things would happen. Firstly, this £1,200 contribution would become £2,000 net of 40% tax relief. Secondly, your full child benefit entitlement would be reinstated, as your ‘adjusted net income’ would now be £50,000.

It’s worth pointing out that there are other factors to consider when calculating your net adjusted income. For example, company bonuses and benefits in kind can push your net earnings back over the threshold again.

Earn between £100,000 and £123,700? Here’s how to turn £800 into £2,000…

Finally, if you earn between £100,000 and £123,700, and you put £1,200 of your after-tax income into a personal pension, this would be topped up by £800 to £2,000 net of 40% tax relief. Then, your adjusted net income would fall by £2,000, and you’d get back £1,000 of your personal allowance.

In effect, this would take another £1,000 out of the 40% tax bracket – which translates into a lower tax bill of £400. All in, a £2,000 net investment into a pension for earners in this income bracket need only cost £800 (a £1,200 initial investment minus £400 thanks to personal allowance reinstatement) – effectively a 60% rate of tax relief.

But once the tax year is over, you lose access to any reliefs you were entitled to more than three years ago. So, make sure you get the most out of your entitlements while you can.

When in doubt, invest in a pension (unless you earn over £150, 000, in which case you should probably talk to an adviser). Even if you’re not affected by the tapering of benefits and allowances due to high earnings, pension saving is possibly the best value for money you’ll get on any investment. So long as you don’t go over the £40,000 annual limit (or 100% of your annual earnings if lower), pension saving is a financial no-brainer.

There are other tax-relievable investments you can use to mitigate your tax bill, but they require a bit more planning and expertise, as they can be risky for the wrong sort of investor. If you would like to gain a better understanding of your holistic financial situation, including maximising tax reliefs and allowances, speaking to an independent financial adviser could be beneficial.

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