Make the most of this year's tax breaks

Cutting your tax bill by using available tax breaks is what every smart investor should be doing. Here are some simple ways to make the most of your annual tax allowances.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. Tax rules can change in future. Their effects on you will depend on your individual circumstances.

What you’ll learn:

  • Tax-efficient ways to save and invest.
  • How much tax relief you’ll receive on your pension contributions.
  • How Inheritance Tax (IHT) works.

There are plenty of tax planning opportunities which can help your keep your tax bills to a minimum without breaking any rules.

Remember, however, that tax rules can change at any time in the future. Any favourable treatment currently available could change later or be removed altogether. In any case, how valuable any tax breaks are to you depends on your individual circumstances, which can also change over time.

Tax should never be the only consideration when you're investing, or even the main one. Always keep in mind that you could lose money and this could outweigh any tax savings you might make.

Remember your personal allowance

Everyone has a certain amount of income they can earn each year without paying tax, known as their personal allowance. For the 2022-23 tax-year, this amount is £12,570 and will continue to increase by the Consumer Prices Index (CPI) measure of inflation.

Your personal allowance is in addition to the Personal Savings Allowance (PSA), introduced in April 2016, which means that most savers no longer have to pay income tax on the savings income, for example interest, they receive.

Your PSA depends on which income tax band you are in, with basic rate taxpayers entitled to a £1,000 allowance, while higher rate taxpayers receive a £500 allowance. Additional rate taxpayers are not eligible for a PSA.

Find out more about the Personal Savings Allowance and what it means for you

Investors also have a dividend allowance which means that individuals receive their first £2,000 in dividends tax-free, but any dividends above this amount will be charged at 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers.

Lots of married couples hold savings accounts in joint names, mainly because it's convenient. However, if one spouse is a higher rate or additional rate tax-payer and the other doesn't pay tax at all, it could be more tax-efficient to put the account solely in the non-taxpayer's name. This would give that spouse full ownership of the account, so you'll need to make sure you're both happy with the arrangement.

Use up your ISA

One of the easiest ways to reduce your tax bill is to shelter any returns above your allowances in an Individual Savings Account (ISA). For the 2022-23 tax-year you can put up to £20,000 into an ISA.

Find out more about our Investment ISA

You can choose to hold all of that in a cash ISA, or put it into a combination of investments, including funds, shares, gilts and bonds through an Investment ISA, or you can invest in peer-to-peer lending through an innovative finance ISA. Alternatively, you can split your allowance between a cash, investment, innovative finance and a lifetime ISA1. However, with a lifetime ISA, you can only pay in up to £4,000 of your £20,000 allowance.

You won't be taxed on any returns from savings or investments above the allowances we’ve mentioned above if your investments are held in an ISA, nor will you have to pay Capital Gains Tax (CGT) on any of the profits you make. That's worth knowing because if your investments aren't held in a tax-efficient wrapper, you'd be taxed on profits above the annual CGT allowance, which in the 2022-23 tax year is £12,300. The standard CGT rate is 10%, while the higher rate is 20%.

Even though the introduction of the PSA and dividend allowance might appear to undermine the appeal of using ISAs, bear in mind that if in the future your returns from savings and investments exceed these allowances you will have tax to pay. Assuming that their current tax benefits continue, ISAs can help protect your returns from tax. But, do remember that tax rules can change in the future.

Find out more about changes to the taxation of dividends

Remember that investments held both in and outside of an ISA, can fall in value as well as rise. You could get back less than you invest and, if you do, your losses can't be offset against other gains. Also bear in mind, tax rules and the rules on ISAs can change.

Topping up your pension

One of the most appealing aspects of pension saving is the boost your contributions receive from tax relief. But you can't touch the money in your pension until you reach the age of 55. However, the Government have announced an intention to link this age to 10 years prior to the State Pension Age. If this passes into law, the minimum pension age will increase in the future, rising to 57 by 2028.

You'll get tax relief at the basic rate of 20% on contributions made to personal and workplace pensions. So for every £80 you pay in, the taxman will top it up to £100. If you're a higher or additional rate taxpayer you can claim back up to an additional 20% or 25% through your self-assessment tax return.

But you’ll need to watch out for the pension Annual Allowance. This is the limit on the amount that can be contributed to your pension each year while still getting tax relief. For the 2022-23 tax-year, for most people, it's £40,000, or the value of your whole earnings - whichever is the lower. Lower allowances may apply if you have already started drawing a pension, or if you are a higher earner with income plus pension contributions that total above £240,000.

If you've used your full allowance in the current tax-year but not in recent years you may also, depending on your circumstances, be able to 'carry forward' any annual allowance which you haven't taken advantage of in the three previous tax years. There's also the Lifetime Allowance to consider. If the value of all your pensions is more than £1,073,100 in the 2022-23 tax tear, anything over this limit will be taxed when you start using it.

There have been a number of reductions in the Lifetime Allowance and there are complex rules about claiming ‘protection' if you were close to, or you exceeded the new limit, having been below the previously higher limit.

You can find detailed information on your allowances, claiming 'protection' and how the 'carry forward' rule works on the Pensions Advisory Service website.

As with ISAs and other investments, remember that investments held in a pension can fall as well as rise. Always keep in mind too that pensions and tax rules could change.

Cutting down on Inheritance Tax (IHT)

ISAs and pensions are the two big ways to shelter your money from tax, but there are other tools, at your disposal.

Your estate is valued when you pass away and chargeable to Inheritance Tax (IHT) at 40%, although the first £325,000 is exempt. Anything that goes to your spouse is also exempt.

Married couples and those in civil partnerships can also benefit from an additional family home allowance, which makes it easier to pass on the family home to direct descendants without incurring IHT charges. This was introduced on 6 April 2017, and was phased in gradually starting at £100,000, and the total IHT threshold stands at £500,000 per person in 2022-23.

Current tax rules enable you to give away up to £3,000 free of IHT each tax year. You can give away more than this amount if you want to but you must live for at least seven years from the date of the gift for it to be exempt from IHT.

Tax rules can be complex, so it’s a good idea to get professional financial advice to help you work out the best ways you might be able to reduce your liability.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances.

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Choose your own investments with Smart Investor using our award-winning Investment ISA (Best Stocks & Shares ISA Provider 2021 at the Shares Awards and Best Stocks & Shares ISA Provider 2022 at the Online Money awards), or let us make the decisions for you with Plan & Invest. Either way, invest up to £20,000 per year and any returns you make are tax-free2.

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