The 2019/20 tax year end is fast approaching, which means now is the time to make the most of your allowances.
Tax planning is not a one-off exercise. 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 £12,500
- The next £37,499 of income is then taxed at 20%, meaning you can earn up to £50,000 gross salary this year and remain a basic rate taxpayer
- Income above this amount, but below £150,000.01 will be taxed at 40%
- Above £150,000, earnings are taxed at 45%.
‘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 net-adjusted 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.
The six-figure curse
Next, there’s what is sometimes known as “the six-figure curse”. Once you start earning over £100,000, you become subject to an effective marginal rate of 60%. This is because for every £2 earned above this threshold, £1 of personal allowance is removed until it’s removed entirely at £125,000. This creates an effective ‘hidden’ tax band between £100,000 and £125,000, where income is taxed at 60%.
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. HMRC offer this handy tax calculator to help you work out your position.
Earn between £100k and £125K? Here’s how to turn £800 into £2,000…
Finally, if you earn between £100,000 and £125,000, 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 £150K, in which case you should probably talk to an adviser (see our article on pensions tapering). 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 not only will reduce your current tax liability but can bring you a longer- term benefit.
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. Remember, any kind of investment bears risk and your personal circumstances should be taken into account before taking any course of action.
If you’d like to gain a better understanding of your holistic financial situation, including maximising tax reliefs and allowances, speaking to an expert independent financial adviser could be beneficial.
The figures quoted in this article are correct at time of publication for tax payers in England, Wales and N Ireland.