Tax efficient saving

How to be tax efficient and save money

Tax efficiency

One of the best ways to boost your income is to take advantage of any tax breaks. These are offered by the government in order to allow people to pay less taxes. Taking advantage of these offers is a legal way of reducing your taxes. Hence why they are called tax efficient.

It is, however, important not to make an investment purely based on saving tax. This is because all investments could potentially lose money. Saving tax whilst your investments decrease in value is not good business sense. If you are looking to make tax efficient investments it is always best to take appropriate financial advice.

Personal Saving Allowance

The Personal Savings Allowance (PSA) allows you to earn up to £1,000 in interest from savings without having to pay tax. This, however, does reduce to £500 for higher rate taxpayers.

Savings that the PSA applies to include current accounts, bank deposit accounts, regular saver accounts, National Savings & Investment (NS&I) accounts, government bonds, peer to peer platforms, corporate bonds and credit union savings.

Individual Savings Accounts

These were first introduced in 1999 to simplify the tax free products and to encourage people to save and invest more money. Individual Savings Accounts (ISAs) are tax efficient and allow you to save £20,000 in a tax free wrapper in 2018/19. This £20,000 can be saved as either cash or invested in shares.

The PSA has reduced the need for many people to hold ISAs as the size of your savings returns needed to exceed the £1,000. Given current interest rates this would mean having somewhere in the region of £20,000 invested. This figure is simply outwith many people’s saving abilities. 

Junior ISAs also exist and these allow children under the age of 18 to have a tax free allowance of £4,260 in cash or shares in 2018/19.

Pensions

Pensions are one of the best tax efficient vehicles available along with ISAs. The introduction of auto-enrolment in the UK means that most workers are now contributing towards a pension. In the year 2018/19 your employer has to contribute 2% of your salary to your pension and you have to contribute 3%. From 6 April 2019 these percentages will increase to 3% from your employer and 5% from yourself.

If you have opted out of auto-enrolment for some reason then you really ought to opt back in as your employer is obliged to pay you a set minimum amount of money and so you are essentially turning down free money.

Paying into a pension allows you to obtain tax relief on your contributions. If you are a basic rate taxpayer in England and Wales and you contribute £8,000 into your personal pension then the government will add £2,000 meaning that in total you have invested £10,000 into your pension.

If you are a higher rate taxpayer then pensions are even more tax efficient for you. This is done by claiming your entitlement through your Self Assessment return or by contacting HMRC. A 40% taxpayer who contributes £6,000 to their personal pension will have £4,000 added to this by the government so pensions really are an extremely tax efficient way of saving money. For 45% taxpayers to get £10,000 they only need to contribute £5,500 and the government will top this up by £4,500.

Types of Pensions

Self Invested Personal Pensions (SIPPs) are similar to personal pensions but offer a far greater choice of how your money is invested. Everyone under 75 can contribute to a SIPP. Parents of children can also set up Junior SIPPs. It is however important to remember that the child will not be able to access the money until they are 55 years old.

Currently anyone over the age of 55 can withdraw 25% of their pension pot as a tax free lump sum. This money can be spent on whatever they want. It is generally advisable to be careful when drawing down and spending your pension money. As always seek financial advice as there could be tax and other implications.

Premium Bonds

National Savings & Investment Premium Bonds allow you to save between £100 and £50,000. Unlike normal savings accounts you Premium Bonds do not earn interest. Instead your bonds are placed in a monthly prize draw where you can win up to £1 million or nothing at all. All prizes are tax free.

Inheritance Tax

In the UK when you die then there is inheritance tax charged on your estate. This is currently charged at 40% on the value of your estate that exceeds £325,000 or £650,000 for those people who are married.

If your estate is likely to be liable to inheritance tax then it is certainly worth taking action sooner rather than later. It is recommended that you speak to a financial adviser to reduce the amount of tax payable to HMRC. Doing so is tax efficient and also allows you to leave more money to your family and descendants.

Capital Gains Tax

CGT is payable when you make profits on selling assets and investments. In 2018/19 the capital gains threshold is £11,700 so as long as your gain is below this figure then no tax is payable.

If the £11,700 allowance is exceeded then CGT is charged at 10% for basic rate taxpayers and 20% for higher rate taxpayers.

Dividend Allowance

The first £2,000 of dividend income you receive is also tax free however once this is exceeded you have to pay tax at 7.5% if you are a basic rate taxpayer, whilst, 32.5% if you are a higher rate taxpayer and 38.1% if you are an additional rate taxpayer.

Sharing economy tax relief

The first £1,000 that you earn from selling stuff on eBay, Gumtree or money you make from blogging is now tax free. Once you exceed this limit however you will be required to pay income tax. Similarly the first £1,000 that you earn from renting out a room from your property is also tax free.

Marriage allowance

There is also a tax break for married couples or civil partners born after 6 April 1935 that allows a partner who is earning less than £11,850 to transfer up to £1,910 of their personal allowance to the higher earning partner. Couples born before 6 April 1935 are entitled to a Married Couples Allowance instead.

Charitable donations relief tax

Higher rate taxpayers who make donations to charity through Gift Aid can claim back 25p for every £1 they donate. This money is claimed back from the government through your self assessment return. Higher rate taxpayers can claim the difference between the basic rate on the donation on their self assessment return. Those who donate than 10% of their estate to charity are therefore able to significantly reduce their Inheritance Tax rate.