The old saying goes that two things in life are certain, death and taxes.
It's estimated that a whopping 14.3 million people - almost half of the UK’s working population - have overpaid on their tax. Alongside this, there are legal methods of reducing your tax bill that many overlook.
Certain outgoings come with tax relief deliberately designed to encourage them, such as charity donations and pension contributions. If you’re doing these, are you ensuring that you are getting the tax back? More on this below.
The following tips should help you reduce the amount of tax you’re paying, legally. The aim isn’t to avoid tax. Tax avoidance schemes can result in an investigation by HMRC, and if it’s found to be tax evasion you could end up in prison.
Check you are on the right tax code
One of the easiest ways to overpay tax is by being on the incorrect tax code for your PAYE earnings. PAYE stands for pay as you earn. It's the money paid to you from your employer after they deduct your tax and national insurance for you.
Your tax code is usually a number followed by the letter L, which tells the government how much your personal allowance is. This is the amount of money you can earn before you have to start paying tax.
As standard this is 1250L, which means you have the full personal allowance of £12,500. If the number is smaller than 1250 the government thinks you should be paying more tax. This could be due to a second job, company benefits such as a company car, or when you owe tax arrears.
If your code is different and you don’t understand why, you could be paying more tax than you need to. This can also happen if you have recently started working at a new employer. Money Saving Expert’s tax calculator gives you a good idea of how much tax you should be paying.
If you do think you’re paying too much you can contact HMRC directly. If there has been an error it’s usually easy to rectify and receive the money you are owed in the form of a rebate.
Use your tax-free personal savings allowance
Each year you can earn £1,000 interest on your savings, before you pay any tax on it, which is known as your personal savings allowance (PSA). If you are in the higher tax rate (you earn between £50,001 and £150,000), then your PSA is reduced to £500. If you earn more than £150,000 (known as the additional tax rate), it is removed completely.
Based on the currents interest rates at the time of writing (Jan 2020) for the top savings accounts, you would need to save over £70,000 to earn enough interest to be charged tax on it. It’s worth noting that if you do fall under this bracket, then you must declare this to HMRC. Bank or building societies no longer pay this tax for you on your behalf.
This doesn’t include any money saved in ISAs, where you are also allowed to save up to £20,000 per year before paying tax (valid for tax year 2019/2020). This means it’s possible to save £90,000 per year without paying tax on the interest.
Utilise your spouse
Marriage may come with a costly wedding, but it can mean tax benefits too - particularly if one of you earns less than the other.
If you use up your savings allowance, you can instead utilise your partner to save money for you. You are also allowed to transfer up to £1250 of your Personal Allowance to your partner, if they earn more than you. This is part of a Marriage Allowance, which can help reduce your partner’s tax bill by up to £250 in a tax year.
For this to make financial sense one of you to be earning less than £12,500 with the other not in the higher or additional tax rate. It can work if one of you takes time off work around the birth of a child.
Make a plan for Inheritance Tax
Inheritance tax, or IHT, is tax paid on the value of your estate after you die. This includes assets such as your home or car, but it can also include life insurance payments.
Your estate has a value threshold of £325,000 before you pay tax on it. You can avoid any tax being paid on the amount above that if you give it to your spouse, civil partner, a charity or a community amateur sports club.
The threshold can increase to £475,000 if you leave your home to your children. This includes adopted, foster or stepchildren, and also your grandchildren. Adding your life insurance policy as a trust may also remove it from being part of your threshold.
If you are concerned that the money you leave loved ones could exceed this threshold, or want to look into putting funds into a trust, it is best to speak to a legal adviser.
While giving money away as a gift and transferring property may seem a viable method of reducing your IHT liability (depending on the sum), don't presume it is. Only expert advice can ensure this is the right process for you (and not land your loved ones with a big tax bill after you’ve died).
Put money away in your pension
Saving money in your pension allows you to qualify for tax relief, and unlike the other suggestions on this list, the percentage increases the higher tax rate you are on. Basic rate taxpayers receive 20% tax relief on all pension payments, with the figure 40% for higher rate and 50% for additional rate taxpayers.
If you contribute to a pension through your work scheme the relief is calculated automatically. You will need to check this happens if you are a higher or additional rate payer. As this money contributes to your own pension pot, this is potentially the most cost-effective way to save money on tax. Although the savings usually can’t be accessed until you are aged over 55.
This is designed to encourage people to save more for retirement to lessen the burden on the state. So capitalise on it!
Check you are in the right house valuation band
It’s not just your income tax you could be overpaying on, but also your council tax as well. Due to inconsistencies in the valuation band process, there’s a chance your house is valued incorrectly and you are in the wrong council tax band.
This article from Money Saving Expert outlines what you should do to check. However, be mindful that many houses are undervalued as well as overvalued - so you could be liable to pay more.
Donate to charity
Any money you donate to charity is exempt from taxation. This includes money you donate to charity directly from your wages as part of a payroll giving scheme. You will only be charged tax on the wages after the charity has been deducted.
This is also the reason why you may be asked to sign a gift aid certificate. When this happens the charity then claim back the tax you’ve paid, getting an extra 25p per every pound donated (20% of £1.25 is 20p).
If you do make donations using gift aid, and you are a higher or additional tax rates payer, you will have been overcharged tax on. This is because the charity will have only claimed it back at 20% instead of the 40% or 45% tax you have paid.
Declaring this on your self-assessment tax return could entitle you to a lower tax bill or a rebate (which you can keep or, of course, donate back to charity). Or you can contact HMRC direct to amend your tax code.
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