Income Tax Planning

Income tax planning is an important aspect of your overall financial planning. There are basic, quite legal, things that you can do to make sure that you are not paying more income tax than you should.

Although many people do not fill in an annual tax return this does not need to mean that the tax deducted by their employer or from their savings and investments is unrecoverable.

Marriage Allowance

If you or your spouse/civil partner were born after 5 April 1935 and have an income below the personal allowance, the marriage allowance offers a potential tax saving. 

That person can transfer 10% of their personal allowance, which is partly being wasted, to their partner providing he or she is not a higher rate or additional rate tax payer.

This could result in an annual saving of up to £252 for the recipient (20% of £1,260).

You can backdate your allowance to include any tax year since 5 April 2018 and boost your payment up to £1,242 as shown below:

Tax yearPersonal allowanceTransfer up to 10%Tax saving at 20%
2018/19£11,850£1,190£238
2019/20£12,500£1,250£250
2020/21£12,500£1,250£250
2021/22£12,570£1,260£252
2022/23£12,570£1,260£252
TOTAL£1,242

Applying for marriage allowance is straightforward and once an application is complete it is processed immediately. The new online form takes less than ten minutes to complete and if you are eligible you will receive backdated claims as a lump sum.

To claim your marriage allowance you can apply here https://www.gov.uk/apply-marriage-allowance

Equalise your savings and investments

The more that you and your spouse or civil partner can equalise the amount of your savings and investments the more scope you will have for saving tax.  This is simply because it is better to be able to claim two personal savings allowances against the interest you receive as a couple than one. The same applies to using two annual dividend allowances.

The exception to this is where one partner is a higher or additional rate tax payer and the other is a non‑tax payer.  Here it would normally be better to hold the greater part of your savings and investments in the name of the non-tax payer.  I appreciate that this might go against the grain as it is usually the highest earner who has the most to invest and decides on where to invest.

Any transfer of assets between you and your spouse or civil partner will usually be capital gains tax and inheritance tax neutral.  This is because transfers between spouses living together are treated as transfers on a no gain/no loss basis for capital gains tax purposes and transfers between UK domiciled souses (living together or not) are exempt from inheritance tax without limit.

Use tax efficient investments

  • ISAs – these are ideal investments as they are tax free (apart from on death when inheritance tax might apply).  They are particularly beneficial if you are a higher rate tax payer or additional rate tax payer. Cash ISAs are very suitable as an emergency fund and stocks and shares ISAs are suitable for providing long term capital growth or income.

  • UK life assurance bonds – these are particularly suitable if you are a higher rate tax payer or additional rate tax payer who is looking for income where the tax is deferred until the bond is surrendered which could be in 20 years’ time. They are also useful if you already tend to use up your annual capital gains tax exempt amount as life assurance bonds are taxed under the income tax regime rather than the capital gains tax regime.

  • Offshore life assurance bonds – these are particularly suitable if you are a higher rate tax payer and your spouse or civil partner is a non-tax payer.  By using an offshore life assurance bond in this situation your spouse can benefit from ‘gross roll-up’ of investment returns and a low rate of tax, or even no tax, on the eventual surrender of the bond.

  • Venture capital trusts – these are only suitable if you have a high attitude to risk and are prepared to invest for at least seven to ten years.  They are particularly tax efficient as they provide up to 30% tax relief on the investment, dividends are tax free and there is no capital gains tax liability.

Is your income above £100,000?

Where your income is above £100,000 your personal allowance is gradually reduced by £1 for every £2 of annual income over £100,000. Therefore once your annual income is over £125,000 you will have no personal allowance. 

As a consequence the marginal rate of tax for your income that falls between £100,000 and £125,000 is actually 60% (tax at 40% higher rate plus tax at 40% on the loss of personal allowance).

If you are able to reduce your income below £100,000 it will save you a lot of tax.  You can do this by making an additional pension contribution.

Example.  If your income is expected to be £118,000 you will lose £9,000 of your personal allowance.

You decide to do something about this and make a net contribution of £14,400 into a pension plan. This will reduce your income by the gross pension contribution of £18,000 because basic rate tax relief of 20% is given at source on the pension contribution.  This will then restore your full personal allowance.

As a higher rate tax payer you will be entitled to a further 20% tax relief on the gross pension contribution (i.e. £3,600) which you will claim via your self-assessment tax return.

The situation is therefore as follows:

 What you haveYour tax rebates
Additional pension fund£18,000
Pension tax relief at source£3,600
Pension tax relief via self-assessment£3,600
Recovered tax on regaining personal allowance (40% of £9,000)£3,600
TOTAL£18,000£10,800

It has therefore cost you £7,200 to set aside £18,000 in a pension fund for later life. You will have to pay tax on this when you withdraw it from your pension fund (either by using pension drawdown or purchasing an annuity), however under current legislation the first 25% is tax free and as far as the excess is concerned you may only be a basic rate tax payer in retirement.

The same effect can be had if your employer were to agree to allow you to use ‘salary sacrifice’.  This is where you agree to reduce your income from £118,000 to £100,000 and your employer makes an £18,000 employer contribution into your pension plan.  This has the added advantage of saving both you and your employer national insurance contributions on the £18,000.

Are you a business owner?

If you own a business and are married or in a civil partnership it can make sense to provide part of the business to your spouse so that part of the business profits or dividends can be taxed on your spouse rather than you.

If your spouse or civil partner is not working outside of the home it can also make sense to employ them in your business.  Income they receive up to the personal allowance will be additional tax-free income to your family and under a certain level neither the business nor your spouse will pay national insurance contributions.

Even if your spouse or civil partner is a tax payer it can still make sense to do these things if you normally pay tax at a higher rate than they do.

Pension Contributions

Pensions are a very tax efficient way to build up funds for your future. With the new pension freedoms it is no longer necessary to purchase an annuity (i.e. an income for life).  Your pension fund can act as a pot of money that you can draw on as and when you wish, currently after age 55 but increasing to age 57 after April 2028.

You can even leave it to your children or grandchildren if you have sufficient other funds to live on in later life.

Gift Aid donations

The government has, for some time, encouraged charitable giving by making a variety of tax reliefs available to donors.  These reliefs benefit charities indirectly since the relief is likely to have the effect of increasing the total amount received by the charity that can be applied for charitable purposes.   

The Gift Aid scheme allows you to make one-off or regular payments to a charity. The charity can claim back basic rate tax from HMRC. If you are a higher or additional rate tax payer you can claim higher or additional rate tax relief, as appropriate, against your income tax.

If you haven’t paid enough tax to cover the tax deducted from your Gift Aid donation(s), HMRC will ask you to pay the difference.

So the charity can reclaim 20p for every £1 (gross) donated by you and if you are a higher rate taxpayer you can reclaim the difference between the basic and higher or additional rates of tax i.e. 20p or 25p for every £1 donated.

Payroll Giving scheme – This scheme allows you to make gifts to a charity by having sums deducted by your employer from your salary through PAYE. The donations are made after National Insurance contributions are calculated but before income tax is worked out and deducted. This means that you get tax relief on your donation immediately – and at your highest rate of tax.


Links to more information

Important

This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.

Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.

If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.