Introduction
Are you eager to find effective ways to trim your tax bill and make the most of your tax savings in the UK? The good news is that there’s an array of tax allowances and tax relief schemes at your disposal. These can help you save taxes and reach your financial goals. In this guide, we will provide an overview of the key tax allowances and relief schemes. We will also share practical tips on how to optimize their utilization.
What are Tax Allowances
Tax allowances represent the income you can earn without incurring any tax liability. It is the threshold above which you start paying taxes. The UK offers various tax allowances and knowing them all can help you optimise your tax savings. Of course, almost every type of tax has its own allowance, all of which are described in this article.
Types of Allowances
Personal Allowance
This is the sum of employment income you can earn annually without being subject to taxation. For the 2022/23 tax year, the personal allowance stands at £12,570. This allowance has been frozen for a while. This, in itself, is a stealth tax, because allowances, especially personal allowance, should increase in line with inflation. The income tax rates in the UK on employment income above the personal allowance are:
| Band | Taxable income | Tax rate | National Insurance |
|---|---|---|---|
| Personal Allowance | Up to £12,570 | 0% | 12% |
| Basic rate | £12,571 to £50,270 | 20% | 2% |
| Higher rate | £50,271 to £125,140 | 40% | 2% |
| Additional rate | over £125,140 | 45% | 2% |
The personal allowance is the same in Scotland but tax bands are different and taxes are generally higher. It is important to know that for each £1 you earn above 100k, you lose 50p of your personal allowance. Which means that additional rate taxpayers do not get a personal allowance. It may make more sense to fix your earnings at 100k (if you can) and contribute the excess to your pension.
Marriage Allowance
If you’re married or in a civil partnership, you can qualify for the marriage allowance. This allows you to transfer up to £1,260 of your personal allowance to your spouse or civil partner. You will only benefit if the lower earner is earning less than the personal allowance. This can result in potential tax savings of up to £252 per year. Another condition is that the partner is paying taxes at the basic rate.
Personal Savings Allowance
Personal savings allowance are essentially for interest earned on savings. The allowance tapers with the tax band. So if you are a basic tax rate payer, you would get £1,000 personal savings allowance (no taxes on the first 1k in interest). This drops to £500 for higher tax rate payers and goes away for additional tax rate payers. Income from interest that exceeds the personal savings allowance is then taxed at the income tax rate.
| Income Tax band | Personal Savings Allowance |
|---|---|
| Basic rate | £1,000 |
| Higher rate | £500 |
| Additional rate | £0 |
Dividend Allowance
Dividends are profits distributed to stock investors. There is an allowance for dividends, which is £1,000 for the 2023/24 tax year. This allowance is expected to come down to £500 for the following tax year. Any additional income from dividends is subject to the tax rates shown below. Note that unlike interest and employment income, dividends have lower tax rates. This is to reflect the fact that this money has already been taxed at the corporate level, since dividends come out of the company’s net profits (profits after tax).
| Tax band | Tax rate on dividends over the allowance |
|---|---|
| Basic rate | 8.75% |
| Higher rate | 33.75% |
| Additional rate | 39.35% |
Trading Allowance
The trading allowance, or the self-employment allowance, is a tax-free £1,000 from any trading activity. This includes selling stuff on eBay, Gumtree, Etsy or Amazon. Also, this includes income from any freelance work on platforms such as Deliveroo, UberEats, TaskRabbit and the likes. You do not need to declare your income from these side hustles if it is within this allowance. Otherwise, you will need to fill out tax self-assessments with HMRC and your income from self-employment or side hustles will be taxed at the employment income tax rates.
Rental Income Allowance
The first £1,000 from a rental property is tax-free in the UK. Unless you are earning through the Rent a Room scheme (to be introduced later), you will need to get in touch with HMRC if you have rental income above this £1,000 allowance. Rental income is subject to the tax rates in table 1.
Capital Gains Tax Allowance
Capital gains tax is levied on the profit realized when selling an asset that has appreciated in value. These assets include property (primary residence exempt), financial assets, jewelry, paintings etc. In fact, most personal possessions worth 6k or more are subject to capital gains taxes, except your car. Each tax year, there is an annual exempt amount for capital gains tax, representing the gain threshold before tax becomes applicable. For the 2023/24 tax year, this annual exempt amount stands at £6,000. The tax rate on capital gains depend on the total taxable income, including the gains from the asset disposal, and the type of asset. Capital gains taxes are higher for property than for other assets:
- Basic tax rate payers pay 10% on taxable gains above the allowance and 18% for property gains.
- Higher tax rate payers pay 20% on taxable gains above the allowance and 28% for property gains.
The following example from HMRC illustrates how capital gains taxes can be calculated:
Your taxable income (your income minus your Personal Allowance and any Income Tax reliefs) is £20,000 and your taxable gains are £12,600. Your gains are not from residential property.
First, deduct the Capital Gains tax-free allowance from your taxable gain. For the 2023 to 2024 tax year the allowance is £6,000, which leaves £6,600 to pay tax on.
Add this to your taxable income. Because the combined amount of £26,600 is less than £37,700 (the basic rate band for the 2023 to 2024 tax year), you pay Capital Gains Tax at 10%.
This means you’ll pay £660 in Capital Gains Tax.
HMRC
Blind Person’s Allowance
If you are registered as blind, you may be eligible for the blind person’s allowance. The allowance is £2,870 for the 2023/24 tax year. This gets added to your personal tax allowance and can also be transferred to the spouse via the marriage allowance.
Inheritance Tax Allowance
Firstly, it should be known that here are no inheritance taxes to pay for estate passed on to the spouse or civil partner, regardless of value. For others, the inheritance tax allowance is £325,000. This goes up to £500,000 if the primary residence is part of the estate. The inheritance tax rate on the value of the estate exceeding the allowance is 40%. Allowances are doubled for a married couple, so when the surviving spouse passes away after inheriting the estate, the allowance goes up to £650,000 (or £1m if the primary residence is part of the estate).
Gift Allowance
You can start giving some of your money in a more tax efficient way in the form of gifts. This is important because the gift allowance is increasing significantly to £20,000 per year in 2024, up from a mere £3,000. Unused gift allowances can be carried forward to the following year. However, there is a £200,000 cap for every rolling 10-year period.
Legal Tax Saving Schemes
In addition to the allowances above, there are a few schemes that can reduce your tax liabilities, all designed and approved by the HMRC. Let us go through the key ones.
Individual Savings Account (ISAs)
The ISA is a tax-efficient wrapper for savings and investments that allows tax-residents to put away up to £20,000 every tax year in one or more of the following accounts:
- Cash ISA: These are savings accounts that pay interest. All interest is exempt from income tax and earned interest in these accounts doesn’t count towards the personal savings allowance.
- Stocks & Shares ISA: These are investment accounts that allow you to invest in financial instruments such as stocks, bonds, REITs and funds. All profits in the ISA are exempt from dividend and capital gain taxes. Like the Cash ISA, dividends or capital gains from assets in the ISA do not count towards your tax allowances.
- Lifetime ISA: This is an investment account where the government tops up your savings by £1 for each £4 you save for up to £1,000 every tax year. The LISA can only be used towards your first home (value <£425,000) or retirement. Maximum contribution to a LISA is capped to £4,000 per tax year and like other ISAs, all gains are tax free. LISAs can be cash or investment (stocks & shares).
You can have all 3 types given that your contributions to all accounts do not exceed £20,000 for the tax-year. Unfortunately, ISAs are not exempt from inheritance tax, meaning they can be taxed at 40% if your estate exceeds the allowances mentioned above.
Junior ISA
The junior ISA is just like the ISAs but for your kids! You can put away up to £9,000 in a Junior ISA every tax year for your kid and the money will grow tax free. Again, they can be cash or investment accounts and the funds become accessible to your child as soon as they turn 18. Bear in mind that the money cannot be withdrawn by anyone else till then, so once the contribution has been made, that money is not yours anymore.
Rent a Room Allowance
If you rent out a room in your primary residence, you could be eligible for the rent a room allowance. This allowance permits you to earn up to £7,500 annually from renting out a room tax-free. To make the most of this allowance, consider utilizing platforms such as Airbnb or other short-term rental services to rent out your spare room when it’s not in use.
Tax Relief Schemes
Tax relief schemes aim to promote investment in specific sectors of the economy by offering tax incentives. Several tax relief schemes are available in the UK, including:
- Enterprise Investment Scheme (EIS): Designed to stimulate investment in small, high-risk companies (early stage startups), the EIS provides income tax relief of up to 30% on investments of up to £1 million per tax year. Additionally, any profits are exempt from all taxes (dividend, capital gain and inheritance tax).
- Seed Enterprise Investment Scheme (SEIS): Similar to the EIS but targeted at smaller, riskier companies (very early stage startups), the SEIS offers income tax relief of up to 50% on investments of up to £100,000 per tax year. Additionally, any profits are exempt from all taxes (dividend, capital gain and inheritance tax).
- Venture Capital Trusts (VCTs): These investment funds focus on small, high-risk companies and offer income tax relief of up to 30% on investments of up to £200,000 per tax year.
- Business Relief: Assets in your private business or shares in an unlisted company can be removed completely from your inheritance tax.
- Agriculture Relief: Agricultural property can also be passed on without any inheritance tax.
To make the most of these tax relief schemes, consider investing in eligible companies or funds. It’s important to acknowledge that these schemes involve a higher level of risk and should be part of a diversified investment portfolio. We encourage you to read our guide on startup investing to understand the risks involved.
Pension Contributions
One way to optimise your tax savings is by making pension contributions via salary sacrifice. This could really save you a lot of money in taxes and increase your net worth by retirement. This is because the contributions are made pre-tax, reducing your tax liabilities. Because you can, in most cases, withdraw one third of your pension tax-free upon retirement, you can avoid paying some taxes indefinitely. Your pension contributions can be made to one of the following:
- Defined Contribution Scheme: These are pension schemes provided by your employer. They tend to match or boost your contributions up to a limit, but nothing stops you from contributing more to your pension.
- Self-Invested Pension Plan (SIPP): If you’d like to have more control over the investments in your pension pot, you can make your contributions to SIPP. You can then choose exactly which investments go into your pension by selecting the stocks, funds, bonds or REITs you want.
All Salary Sacrifice Schemes
Any scheme working on a salary sacrifice basis will save you money on your taxes. These include cycle to work schemes and EV lease schemes, among others. Unfortunately, not every employer offers all these schemes, so check with your HR department. But making large purchases for bikes, cars or gadgets via salary sacrifice will save you on taxes. The only consideration with these salary sacrifice schemes (pensions included) is that your gross salary is reduced. So when going for a mortgage, the bank or building society will calculate how much they can lend you based on a slightly lower salary (usually 4.5x gross salary).
Conclusion
As seen in this article, taxes in the UK are quite complex. But by leveraging tax allowances and tax relief schemes, you can effectively reduce your tax burden and maximize your tax savings. Whether you’re self-employed, an investor, or a homeowner, opportunities abound for lowering your tax liability. To ensure you capitalize on these opportunities to the fullest extent, it’s advisable to seek guidance from a qualified tax specialist who can provide professional advice tailored to your unique financial circumstances.
