Tax Saving Tips for the UK resident

The Ultimate Guide to Tax Saving Opportunities in the UK

Personal Tax Jun 21, 2024

In the complex landscape of UK taxation, understanding and utilising available tax saving opportunities can significantly impact your financial well-being. Whether you're a salaried employee, self-employed, a business owner, or an investor, the UK tax system offers various legitimate ways to reduce your tax liability and maximise your earnings.

This comprehensive guide explores a wide range of tax saving strategies available to UK residents. From leveraging ISAs and pension contributions to understanding capital gains tax reliefs and inheritance tax planning, we'll delve into both common and lesser-known opportunities that could help you keep more of your hard-earned money.

It's important to note that while tax planning is a crucial aspect of financial management, it should always be done within the bounds of the law and in line with HMRC regulations. The strategies discussed in this article are intended to help you navigate the tax system efficiently, not to evade your tax responsibilities.

As we explore these opportunities, remember that tax laws and allowances can change annually. What works best for you will depend on your individual circumstances, income level, and financial goals. With that in mind, let's dive into the world of UK tax savings and discover how you can make the most of the available opportunities.

1. Income Tax Savings

Personal Allowance

The Personal Allowance is the amount you can earn before you start paying income tax. For the 2023/24 tax year, this is set at £12,570.

Example: If you earn £20,000 per year, only £7,430 (£20,000 - £12,570) will be taxed.

Strategy: If you're married or in a civil partnership, and one partner earns less than the Personal Allowance while the other is a higher rate taxpayer, consider transferring income-producing assets (like savings accounts or rental properties) to the lower earner. This can reduce the overall tax paid by the couple.

Salary Sacrifice

Salary sacrifice involves giving up part of your salary in exchange for non-cash benefits from your employer.

Example: If your employer offers a cycle-to-work scheme, you could agree to sacrifice £1,000 of your salary in exchange for a £1,000 bike. You don't pay tax or National Insurance on the sacrificed amount, potentially saving hundreds of pounds.

Tax Code Check

Your tax code determines how much tax is deducted from your salary. Errors can lead to overpaying.

Example: If you've recently changed jobs or have multiple sources of income, your tax code might be incorrect. For instance, if you're on an emergency tax code (often 1257L W1/M1), you might be paying too much tax initially.

2. Pension Contributions

Tax Relief on Contributions

Pension contributions receive tax relief at your marginal rate. For people with income between £100K and £125K where the effective marginal tax rate is 60% because of the progressive loss of the personal allowance, contributing to a pension is probably the most tax efficient step they can take.

Example: If you're a basic rate taxpayer (20%) and contribute £100 to your pension, it actually only costs you £80, as the government adds £20 in tax relief. For higher rate taxpayers (40%), a £100 contribution effectively costs just £60.

Carry Forward Unused Allowances

You can use unused pension allowances from up to three previous tax years as long as you had a pension plan open.

Example: If you've used only £20,000 of your £40,000 allowance in each of the last three years, you could potentially make a contribution of up to £100,000 in the current year (£40,000 for this year plus £60,000 unused from previous years), subject to having sufficient earnings.

3. ISAs (Individual Savings Accounts)

ISAs are tax-efficient savings and investment accounts available to UK residents. They offer a way to save or invest money without paying tax on the interest, dividends, or capital gains.

3.1 Types of ISAs

Cash ISA

  • Saves cash tax-free
  • Interest rates can be fixed or variable
  • Easy access and fixed-term options available
Example: If you're a higher rate taxpayer and earn £500 interest on £20,000 in a Cash ISA, you keep all £500. In a standard savings account, you'd only keep £300 after tax.

Stocks and Shares ISA

  • Invests in stocks, bonds, and funds tax-free
  • Potential for higher returns than Cash ISAs, but with higher risk
  • Can hold individual shares, funds, investment trusts, and ETFs
Example: If your £20,000 Stocks and Shares ISA grows to £25,000 and you sell, the £5,000 gain is tax-free. Outside an ISA, you might pay Capital Gains Tax on gains over the annual allowance.

Innovative Finance ISA

  • Invests in peer-to-peer lending
  • Potentially higher returns than Cash ISAs, but with higher risk
  • Interest earned is tax-free
Example: You invest £10,000 in an IFISA earning 6%. The £600 interest is tax-free. A higher rate taxpayer would need to earn 10% in a standard account to get the same after-tax return.

Lifetime ISA

  • For 18-39 year olds saving for a first home or retirement
  • Government adds 25% bonus on contributions up to £4,000 per year
  • Can be cash or stocks and shares
Example: You save £4,000 in a Lifetime ISA. The government adds £1,000, giving you £5,000 total. If used for a first home or after age 60, this is tax-free.

Junior ISA

  • For children under 18
  • Parents or guardians can open and manage the account
  • Child takes control at 16, can withdraw at 18
  • Can be cash or stocks and shares
Example: You open a Junior Stocks and Shares ISA for your newborn, investing £9,000 (the 2023/24 limit). If it grows by 5% annually, it could be worth about £24,000 when your child turns 18, all tax-free.

3.2 ISA Allowance and Rules

  • Total ISA allowance: £20,000 per tax year (2023/24)
  • You can split this allowance between different types of ISAs
  • Junior ISA allowance: £9,000 per tax year (2023/24), separate from the adult allowance
  • You can only open one of each type of ISA per tax year
  • You can transfer ISAs between providers without affecting your allowance
Example: You could put £10,000 in a Cash ISA, £6,000 in a Stocks and Shares ISA, and £4,000 in a Lifetime ISA in the same tax year.

3.3 ISA Strategies

  1. Use your full ISA allowance each year if possible
  2. Consider stocks and shares for long-term savings to potentially beat inflation
  3. Use Lifetime ISAs for first-time home purchases or retirement savings
  4. Start Junior ISAs early to maximise the power of compound growth
  5. Review and rebalance your ISA portfolio regularly
Example: A couple with a child could potentially save £49,000 tax-free per year (£20,000 each in their ISAs, plus £9,000 in a Junior ISA).

3.4 Considerations

  • Cash ISAs may currently offer lower rates than some high-interest savings accounts
  • Stocks and Shares ISAs and Innovative Finance ISAs carry investment risk
  • Lifetime ISA withdrawals for other purposes incur a 25% penalty
  • Money in a Junior ISA belongs to the child and can't be withdrawn until they're 18

Remember, while ISAs offer excellent tax benefits, it's important to consider your overall financial situation and goals when deciding how to save or invest. Always seek professional advice if you're unsure about the best approach for your circumstances.

4. Capital Gains Tax (CGT) Strategies

Annual Exemption

You can realise capital gains up to £6,000 (2023/24) without paying CGT.

Example: If you bought shares for £10,000 and they're now worth £15,000, you could sell £6,000 worth this tax year and £6,000 worth next tax year, potentially avoiding CGT entirely.

Tax-Efficient Investments

Investments in EIS offer 30% income tax relief and CGT deferral.

Example: If you invest £10,000 in an EIS-qualifying company, you can reduce your income tax bill by £3,000. If you've recently realised a capital gain, you can also defer paying CGT on that gain by reinvesting it into an EIS.

5. Inheritance Tax (IHT) Planning

Gift Allowances

You can give away £3,000 per year free of IHT, plus make small gifts of up to £250 per person to any number of people.

Example: A couple could give their child £6,000 per year (£3,000 each) towards a house deposit, and this would be immediately outside of their estate for IHT purposes.

Business Property Relief

Certain business assets can qualify for 100% relief from IHT after two years.

Example: If you own shares in an unlisted trading company worth £500,000, these could potentially be passed on free of IHT, saving up to £200,000 in tax (at the 40% IHT rate).

For other examples of IHT planning see our article on inheritance tax planning.

6. Tax-Efficient Investments

Tax-efficient investments offer UK residents opportunities to potentially reduce their tax liability while growing their wealth. Here's an in-depth look at some key options:

6.1 Venture Capital Trusts (VCTs)

VCTs are investment companies listed on the London Stock Exchange that invest in small, young, and often high-risk UK businesses.

Benefits:

  • 30% income tax relief on investments up to £200,000 per tax year
  • Tax-free dividends
  • Capital gains tax exemption on profits from VCT shares
Example: If you invest £10,000 in a VCT, you can claim £3,000 as a tax credit, reducing your income tax bill for the year. If the VCT pays a 5% dividend (£500 on your £10,000 investment), this is tax-free. If you later sell your VCT shares for £15,000, the £5,000 gain is exempt from capital gains tax.

Considerations:

  • You must hold the shares for at least five years to keep the income tax relief
  • VCTs are high-risk investments and you may not get back the amount you invested
  • Not all VCTs pay regular dividends

6.2 Enterprise Investment Scheme (EIS)

The EIS encourages investment in smaller, unquoted trading companies.

Benefits:

  • 30% income tax relief on investments up to £1 million per tax year (or £2 million if at least £1 million is invested in knowledge-intensive companies)
  • Capital gains tax deferral on gains reinvested into EIS-qualifying companies
  • Tax-free growth
  • Loss relief if the companies fail
Example: You invest £50,000 in an EIS-qualifying company. You can reduce your income tax bill by £15,000 (30% of £50,000). If you recently sold some shares and made a £40,000 gain, you could defer the capital gains tax on this by reinvesting into the EIS. If the EIS shares are later sold for £75,000, the £25,000 gain is tax-free.

Considerations:

  • Shares must be held for at least three years to retain the income tax relief
  • Investments are in small, often early-stage companies and carry high risk
  • Not all EIS investments qualify for all the tax reliefs

6.3 Seed Enterprise Investment Scheme (SEIS)

SEIS is designed to encourage investment in early-stage companies.

Benefits:

  • 50% income tax relief on investments up to £100,000 per tax year
  • 50% capital gains tax relief on gains reinvested into SEIS-qualifying companies
  • Tax-free growth
  • Loss relief if the companies fail
Example: You invest £20,000 in an SEIS-qualifying company. You can claim £10,000 as a tax credit against your income tax bill. If you had a capital gain of £10,000 in the same tax year, you could claim 50% relief on this gain, saving an additional £1,400 in capital gains tax (assuming a 28% CGT rate).

Considerations:

  • Extremely high-risk due to the early-stage nature of the companies
  • Shares must be held for at least three years to retain the tax reliefs
  • Limited investment opportunities due to strict qualifying criteria for companies

6.4 Premium Bonds

Premium Bonds are a savings product issued by National Savings and Investments (NS&I), backed by HM Treasury.

Benefits:

  • Chance to win tax-free prizes in monthly draws
  • Capital is secure and backed by the government
  • Easy to cash in
Example: You hold £10,000 in Premium Bonds. Instead of earning interest, you have a chance to win prizes ranging from £25 to £1 million. If you win a £100 prize, this is equivalent to a 1% return on your £10,000, but it's completely tax-free. A higher-rate taxpayer would need to earn 1.67% in a savings account to achieve the same after-tax return.

Considerations:

  • No guaranteed return – you may win nothing
  • The effective "interest rate" depends on luck and the amount invested
  • Inflation may erode the real value of your capital over time

6.5 Innovative Finance ISAs (IFISAs)

IFISAs allow you to use some or all of your annual ISA allowance to invest in peer-to-peer lending.

Benefits:

  • Tax-free interest on your peer-to-peer loans
  • Potential for higher returns compared to Cash ISAs
  • Contributes to your overall £20,000 ISA allowance
Example: You invest £10,000 in an IFISA offering 6% returns. After a year, you've earned £600 in interest, all of which is tax-free. A higher-rate taxpayer would need to earn 10% interest in a standard savings account to achieve the same after-tax return.

Considerations:

  • Higher risk than Cash ISAs – your capital is at risk and returns are not guaranteed
  • May be less liquid than other investments – it might take time to withdraw your money
  • The peer-to-peer lending market is relatively new and untested through a full economic cycle

When considering tax-efficient investments, it's crucial to remember that tax treatment depends on individual circumstances and may change in the future. Many of these investments carry significant risks, and it's important to thoroughly understand these risks and how they align with your financial goals and risk tolerance. Always seek advice from a qualified financial advisor before making investment decisions.

Rent a Room Scheme

You can earn up to £7,500 per year tax-free by renting out a furnished room in your home.

Example: If you rent out a room for £625 per month (£7,500 per year), this entire amount would be tax-free under the scheme.

Principal Private Residence Relief

Your main home is usually exempt from CGT when you sell it. Please check our article on PPR relief for more details.

Example: If you bought your home for £200,000 and sell it for £300,000, the £100,000 gain is typically tax-free. This relief can also apply partially to homes you've lived in for only part of the ownership period.

8. Business Owners and Self-Employed

Claiming Expenses

Ensure you're claiming all allowable business expenses to reduce your taxable profit.

Example: If you're self-employed and use your personal phone for business calls, you can claim a proportion of your phone bill as a business expense.

Trading Allowance

The first £1,000 of income from trading or casual services is tax-free.

Example: If you occasionally sell handmade crafts online and make £900 in a year, this entire amount would be tax-free under the trading allowance.

Incorporation

For some businesses, operating as a limited company can be more tax-efficient than being a sole trader.

Example: As a sole trader earning £50,000, you'd pay income tax and National Insurance on your profits. As a limited company, you could pay yourself a lower salary (e.g., £12,570 to use your full Personal Allowance) and take the rest as dividends, potentially reducing your overall tax bill.

Conclusion

Navigating the UK tax system can be complex, but understanding and utilising the various tax saving opportunities available can lead to significant financial benefits. From making the most of your personal allowance and ISA contributions to strategic pension planning and inheritance tax considerations, there are numerous ways to legally and ethically reduce your tax burden.

Key takeaways from this guide include:

  1. Maximise tax-free savings and investments through ISAs, including Junior ISAs for children.
  2. Take full advantage of pension tax relief and allowances.
  3. Understand and utilise capital gains tax exemptions and reliefs.
  4. Consider tax-efficient investments like VCTs and EIS for potential tax benefits.
  5. Plan ahead for inheritance tax to protect your estate.
  6. If you're self-employed or a business owner, ensure you're claiming all eligible expenses and consider whether incorporation could be beneficial.

Remember, while these strategies can be powerful tools in your financial planning toolkit, it's crucial to consider your overall financial situation and long-term goals when making decisions. What works best for one person may not be the optimal solution for another.

Have Questions? Contact us for a free consultation.

Moreover, tax laws and allowances are subject to change, and some tax saving opportunities may have associated risks or restrictions. It's always advisable to stay informed about the latest tax regulations and seek professional advice from a qualified tax advisor or financial planner. They can provide personalised guidance based on your specific circumstances and help you create a comprehensive tax strategy that aligns with your financial objectives.

By staying informed and proactive in your tax planning, you can ensure that you're making the most of the opportunities available to you, potentially saving significant amounts of money in the process. Remember, effective tax planning is not about avoiding taxes, but about not paying more than you legally need to. With the right approach, you can navigate the UK tax system efficiently and keep more of your hard-earned money working for you.

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Franck Sidon

With over 15 years of experience as a Managing Director at TaxAssist Accountants, I have helped thousands of businesses and individuals achieve their financial goals and optimize their tax efficiency.

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