A growing number of people are expected to pay higher-rate income tax in the coming years, but there are several ways to make your money work harder, from tax-efficient pensions and ISAs to tailored financial advice.
Benjamin Franklin wrote: ‘In this world nothing can be said to be certain, except death and taxes.’ The inevitability of taxes and their necessity for a functioning society is clearly nothing new. Yet the extent of taxation we face is often far from certain, and the UK’s complex system is perhaps one reason why an increasing burden for many of us went somewhat unnoticed. That is until its cumulative impact coincided with the seismic, post-pandemic increase in the cost of living. It has led to a drop in living standards that would have been hard to imagine a decade ago.
The current nature of higher taxes is characterised not by an increase in percentages levied, but the more surreptitious approach of freezing thresholds at which people start to pay tax, or are tipped into higher tax brackets. In the past, these levels and allowances have generally followed inflation and wages higher, give or take, but the present regime gradually increases the tax load as incomes rise and thresholds fail to keep up, a phenomenon known as ‘fiscal drag’.
While politicians can claim there are no tax rises with this approach, the reality is the amount paid increases over time for those whose incomes or profits rise – which is hopefully the case for most people over the course of the career or business life. Similarly, retirement incomes that are inflation linked or increase by some other means encumber a higher chunk of tax, including the State Pension which rose by 10.1 per cent earlier this year. Thus, the freezing of allowances and thresholds for income tax is progressively eating away at almost everyone’s take-home pay or other income sources.
This is set to worsen. Overall, one in five of all taxpayers will pay income tax at 40 per cent by 2027* as things stand, according to the Institute for Fiscal Studies, including one in eight nurses and one in four teachers. In addition, the 45 per cent additional rate threshold has been reduced this 2023/24 tax year from £150,000 to £125,140, dragging a greater number of higher earners into the very top rate.
What’s more, a brace of important allowances has been truncated. The capital gains tax allowance, which allows an individual a certain level of tax-free profits on their investments each year, has been cut from £12,300 in the 2022/23 tax year to £6,000 in the current tax year, and is set to fall by half again in 2024/25.
Also part of last year’s Autumn Statement was the reduction in the dividend allowance, the level at which individuals pay no tax on dividend income. Having been as much as £5,000 in 2017, it is now set to almost disappear altogether, falling to £1,000 this tax year and to £500 in 2024/25. Swathes of people will be affected, from pensioners taking modest income from their shareholdings to small business owners paying themselves in dividends.
The good news is there are ways to ensure your finances are as tax efficient as possible and it’s not too late to act to address the latest changes. Here are five things to consider – but remember: if you are in doubt or your finances are more complex, it is well worth getting professional help to ensure you are doing all you can while keeping within the rules.
Use your ISA allowance
The increasing tax burden reinforces the case for utilising ISAs, be they cash ISAs as a savings account or stocks and shares ISAs that allow you to shelter investments from tax. You can put in up to £20,000 a year and any returns you make will be tax-free. If you use a provider, like Charles Stanley, which provides flexible ISAs you can even withdraw from your account and keep your allowance, provided you pay the money back in the same tax year.
Make pension contributions
An increase in the pension annual allowance and the abolition of the lifetime allowance is the silver lining for those looking to save tax. Currently, anyone under 75 with UK earnings can receive tax relief when they contribute within the annual allowance to a personal pension. Twenty per cent is added in automatically and any further higher or additional rate income tax relief can be reclaimed – potentially a simple way of reducing your income tax bill for the year.
Be careful when you sell assets
Those with significant investments outside of tax-efficient wrappers such as shares, or second properties need to take care with regard to both income and capital gains on sale. Timing of sales may also be important in order to minimise tax, though this has to be balanced with the investment outlook.
Think about who owns what
Shifting income-producing assets into the ownership of a spouse or partner with a lower income and tax rate can make sense. It is also worth noting that married couples and those in civil partnerships can transfer assets to each other to make use of two CGT allowances, or they can look to move all of a potential gain to a partner who is in a lower tax band.
Make plans for the wealth transfer between generations
Inheritance tax was originally deemed to apply only to the rich, but now a much greater proportion of the population is affected. Forty per cent tax is payable on assets over an individual’s nil-rate bands, which are set to remain frozen. There are some simple ways to reduce the amount your estate pays, as well as some more complex methods. Depending on the situation, the gifting of assets, use of pensions, AIM portfolios attracting Business Property Relief and gifts into a trust can play a role.
If you’d like to find out more about Charles Stanley, we host frequent webinars to help you and your family secure your financial future. Explore our upcoming events or call 020 3797 6853
The value of investments, and the income derived from them, can fall as well as rise. Investors may get back less than invested. Charles Stanley is not a tax adviser. Information contained in this article is based on our understanding of current HMRC legislation. Tax reliefs are those currently applying and the levels and bases of taxation can change. Tax treatment depends on the individual circumstances of each person or entity and may be subject to change in the future. If you are in any doubt, you should seek professional tax advice. Charles Stanley & Co. Limited is authorised and regulated by the Financial Conduct Authority.
By Rob Morgan, Chief Analyst, Charles Stanley