Avoid paying 60% tax
The Chancellor is working incredibly hard to close down loopholes but there are still many legitimate and socially acceptable ways of reducing tax. Individuals who have significantly fluctuating incomes are at greater risk of paying more tax than needed.
It’s important to have as much visibility as possible on your taxable income before the tax year end when you may still have planning options. For example, you might think the top rate of income tax is currently 45% but in some circumstances it is, in effect, 60%. That is the marginal rate you pay on taxable income in the bracket £100,000 – £122,000.
The most popular way of reducing your taxable income is via pension contributions
The most popular way of reducing your taxable income is via pension contributions and these become especially tax efficient when top income falls in this band. A £20,000 contribution could save up to £12,000 in tax. Charitable donations also work in a similar way except that the charity receives the benefit of Gift Aid.
New rules for pension contributions
Pension allowances have now been capped at £10,000 for top earners. If taxable income sits in the £150,000 to £210,000 band, the pension allowance will be a moving feast, reducing from £40,000 to £10,000.
However, high earners also need to watch out for breaching the Lifetime Allowance, which has reduced to £1 million. That might still seem like a large sum but it’s likely to become a real issue for a successful individual. For example, a fund of £620,000 growing at 5% per annum will exceed the allowance in 10 years. If breaching the allowance seems a real possibility then consider de-risking the portfolio. Drawing benefits early is another option but this creates other risks in a world of extending life expectancy.
Using tax wrappers efficiently
Managing the division of investments between those in tax wrappers such as ISAs and pensions and those held directly is becoming even more important. The general guideline should be to allocate assets that generate interest income or rental income to tax free wrappers, such as ISAs and pensions.
The taxation of investment income has changed significantly from this tax year. The first £5,000 of dividends are now tax free and depending on your tax position, up to £1,000 of interest will be tax free. Taken together with the Capital Gains Tax (CGT) annual allowance of £11,100 that means it may be possible to generate £17,100 tax free per annum. That’s probably enough leeway to accommodate a portfolio of £250,000 or so, provided it is tax optimised.
For larger portfolios offshore bonds can be a useful means of deferring the tax payable on investment returns, especially if there is a longer term intention to live abroad or you expect to pay lower tax rates in retirement.
Used your ISA and pension allowances?
If you have used your pension and ISA allowances, but would like to invest in other tax efficient vehicles, you could look at Venture Capital Trusts (VCTs) or Enterprise Investment Schemes (EIS). Both these schemes offer 30% Income Tax relief in return for investing in British companies. However, it is important to note that they do NOT rediuce your taxable income. M
For more information visit the VCT section on our site.
Related case studies
Ellen is the chief executive of a design agency with an income of £123,000 p.a. in the current tax year.
I have a question...
Some Free EQ Guides
Coming into money isn’t something that happens often. Before you commit yourself to spending, investing, giving gifts or even giving up your job, here are some tips on how to make your windfall work for you in the long run.
EQ is a Chartered Financial Planning firm able to offer a wide range of services to private clients including tax optimisation, retirement income planning and estate planning.
The April 2015 Budget saw the most radical changes to the pensions landscape for a generation, but the new flexibility on offer is only available to personal pension holders. Members of final salary schemes can only access the new rules by transferring to a personal pension.
This guide explains how planning ahead of time can provide for – and in most cases reduce – the amount of tax that is ultimately due on your estate.