As tax thresholds are frozen for the next 5 years, many people will find themselves paying more tax. Anyone who pays tax on dividends or National Insurance contributions will also face an increase of 1.25%.
If you haven’t thought about tax-efficient financial planning before, the current tax year might be a good time to start. With costs rising across the board, a reduction to your annual tax bill might make life a little easier.
The main steps you should take for a tax-efficient 2022/2023 are described below.
Reduce Your Income Tax
If you are earning a salary, there are a few steps you can take to reduce your tax liability.
- Contribute to your pension via salary sacrifice. Not only will this reduce your taxable earnings, it will also reduce the amount of National Insurance paid by you and your employer. Pensions are covered in more detail below.
- You can claim expenses for any costs incurred while working, including business mileage and working from home allowance.
- Check your tax code is correct. If you have received any ad hoc income, such as a pension withdrawal or a bonus, HMRC may assume that you will receive the same amount every month, and tax your remaining income accordingly. This is easily corrected by contacting HMRC.
- Claim tax-free childcare if you have a child under 11, pay childcare costs, and earn under £100,000 per year. This can save up to £2,000 per year.
- If you regularly travel for work, a company car, vehicle allowance, or season ticket loan can all save on costs and tax.
Tips for Business Owners
Business owners have even more control over their tax position than salaried employees. The following might help to save on tax:
- If you are a sole trader or a partnership, you may want to consider setting up a limited company. This gives you more control and flexibility over your income. Taking the majority of your income as dividends has two main advantages:
- You have a tax-free dividend allowance of £2,000 per year on top of your personal allowance.
- Dividends are not subject to National Insurance contributions.
- The business can cover various expenses that are incurred in your trade, including materials, stationary, travel, training, and phone bills.
- Your pension contributions from the company are an allowable business expense.
Top Up Your Pension
Pensions are one of the most tax-efficient investment options. The main tax advantages are:
- Personal contributions receive automatic tax relief of 20%. This means that for every £100 you contribute, HMRC will add £25. Gross contributions (including tax relief) are capped at the higher of your UK earnings from salary or trade and £3,600.
- Employer contributions are an allowable business expense and do not incur tax or National Insurance for the company or the employee.
- The pension fund grows free of tax.
- When you retire, you can take 25% of your pot as a tax-free lump sum. The remainder will be taxed at your marginal rate, but only when you take withdrawals.
- Pensions are not subject to Inheritance Tax and can be passed on free of tax if you die before age 75. After age 75, your beneficiaries will simply pay their normal rate of tax on any withdrawals they take.
Of course, there are a few limits and restrictions:
- Personal and employer contributions are subject to the annual allowance of £40,000 per year. This can be carried forward by up to three tax years in some circumstances.
- If you earn over £240,000 or have taken taxable benefits from a money purchase pension, your annual allowance will be reduced.
- If your pension exceeds £1,073,100, the excess will be taxed at up to 55% when you take benefits, die, or reach age 75.
If you don’t already have a pension, the current tax year could be a good time to start one, either through your employer or independently. Not only will it save on tax, but it will help bring you closer to your retirement goals.
If you do have a pension, 2022/2023 could be a good time to increase your contributions, providing you remain within the limits explained above.
To invest tax-efficiently in 2022/2023:
- Use your ISA allowance. You can invest up to £20,000 per year in a tax-efficient ISA. If you don’t use your ISA allowance every year, you can’t make up the difference later.
- You can also invest up to £9,000 per year in Junior ISAs for your children.
- A Lifetime ISA could be the best option if you are looking to get on the property ladder. Your contributions will receive a 25% bonus (capped at £1,000 per year) providing you use the fund for a first home or stay invested until at least age 60.
- Utilise your capital gains tax (CGT) exemption by switching funds, withdrawing an income, or moving taxable investments into your ISA. You can realise gains of up to £12,300 per year without paying CGT.
- Dividend allowance (£2,000 per year) personal savings allowance (up to £1,000 per year depending on your tax bracket), and the starting rate for savings (tax free savings income of up to £5,000 if you earn less than £17,570) can all reduce the tax you pay on your investment income.
- Some higher risk investments can help to mitigate income tax, capital gains tax, and sometimes Inheritance Tax. Advice is recommended as these investments are not suitable for everyone.
If you are married, there are a number of ways that couples can combine their allowances to save on tax:
- If you are a basic rate taxpayer and your spouse earns less than £12,570 per year, they can allocate up to £1,260 of their tax-free personal allowance to you. This could save up to £252 over the year.
- Assets can be transferred between spouses without CGT implications. This means that a couple can realise gains of up to £24,600 without a CGT liability.
- You can allocate investments between spouses to make use of the various income tax allowances.
You can also think about reducing your potential Inheritance Tax (IHT) liability. Options include:
- Gifting up to £3,000 in the current tax year. This is immediately outside your estate. You can also use the previous year’s allowance if you have not already done so.
- You can gift a higher amount on a regular basis, providing this is affordable from surplus income.
- Lump sum gifts, either made directly or into trust, remain in your estate for seven years. Making the gift in the current tax year will start the clock ticking to reduce your liability earlier.
Effective tax planning is an essential part of good financial planning. If you take some of the steps outlined above, the tax savings over the years could be significant.
Please don’t hesitate to contact a member of the team to find out more about financial planning.