How would you like to pay less tax on your earnings? 

We all want to retain as much of our income as we can. However, too often people end up losing money unnecessarily to taxation, which might have otherwise been avoided. So, how can you make your tax strategy more efficient?

In this blog post, we’ll examine some of the tax allowances at your disposal and how to maximise their potential amidst mounting government cuts.

1. Pension contributions

Every individual in the UK has a personal allowance – that is, the amount of money they can earn without paying any income tax. If you earn below £100,000, you get a personal tax-free allowance of £12,570. However, for every £2 earned above this £100,000 threshold, you lose £1 from your tax-free allowance.

This means that you could end up paying up to 60 per cent of your income in taxes! So, how do you escape this 60 per cent tax trap? 

An effective solution would be to make pension contributions that reduce your earnings to under £100,000.

For example, let’s assume you earn £110,000. A £10,000 pension contribution will lower your taxable income to just below the £100,000 mark, potentially saving you up to £6,000 in taxes. 

This not only helps you retain the bulk of your money, but it also paves the way for a financially secure retirement by filling your pension pot.

2. Venture Capital Trust (VCTs)

VCTs are another effective way to lower your tax bill if you don’t mind your money being tied up for a few years. The major benefit associated with this type of investment is that it offers an upfront reduction in your income tax bill and the potential for tax-free dividend payouts.

With VCTs, you can claim up to 30 per cent income tax relief on the amount you invested. For example, if you invested £10,000, you’ll get up to £3,000 off your tax bill each year.

However, it’s still important to note that they carry a significant risk factor. VCTs invest in smaller companies, and these investments can fall or rise in value much more sharply than shares in larger companies. They also have a higher rate of failure, which means you could lose some or all of the money you’ve invested.

Moreover, you have to hold VCT shares for a minimum of five years, or you will be required to repay any upfront income tax relief you’ve claimed. So, before you dip your toes into a Venture Capital Trust, make sure you have an appetite for risk.

3. Dividends

Running your business as a limited company can be a tax-efficient way to operate. If you own a limited company, you can get dividends, at which point you’ll have to pay dividend tax. However, the rates of tax you pay on dividends are significantly lower than income tax rates. This explains why most directors generally draw between £8,000-£10,000 in PAYE earnings and then take the majority of their income in the form of dividends.

Lower tax rates and no national insurance contributions (NICs) – all very beneficial for anyone looking to preserve as much of their income as possible.

4. Tax-efficient wealth transfer strategies

As we’ve mentioned in previous blogs and podcasts, there are numerous ways to transfer the full value of your wealth to beneficiaries. For example, married couples can freely transfer wealth between themselves. If one partner earns significantly more than the other, they can make the most of their spouse’s tax exemptions to maintain the highest possible value. 

In cases where you’d like to leave some money behind for your heirs, there are efficient tactics to mitigate inheritance tax. This will help ensure that your beneficiaries aren’t burdened with any more tax than absolutely necessary.

Check out our blog on navigating the probate process for your beneficiaries here. 

Making the most of your free allowances

Over the course of this blog, we’ve highlighted several allowances that could enhance the efficiency of your tax strategy. It’s crucial to remember, though, that these allowances have been reduced in recent years and are expected to continue dwindling with each passing tax year.

Currently, the government has sliced the dividends you can earn before being taxed from £2,000 down to £1,000. The capital gains allowance has also been slashed from £12,300 to £6,000. By 2024, it will drop even further to £3,000. 

That’s why it’s so important to capitalise on these allowances before they change for the worse. By implementing these strategies outlined above, you’re not only putting more money in your pocket today, but also ensuring you’re financially prepared for the future. 

There are more ways to remain tax efficient this year – too many to list here. For some more details, feel free to check out our podcast A Dab Of Investment.

And if you’d welcome our input, expertise and experience, please get in touch by emailing me at alex@applewoodindependent.co.uk. 

The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.

The value of your investment can go down as well as up, and you may not get back the full amount invested.

Past performance is not a guide to future performance.