This article takes a look at some of the factors to take account of when planning to reduce your personal tax liabilities.
The overriding aim of all personal tax planning is to legally reduce the amount of tax paid on an individual’s income.
This income can come from a number of sources and the tax reduction strategies available will be based on the reliefs and allowances applicable to each source.
For the 2016/17 tax year, most people’s personal allowance is £11,000.
Thereafter your income is subject to tax at:
- 20% on the first £0 to £32,000 known as the Basic Rate Band
- 40% between £32,001 to £150,000 known as the Higher Rate Band
- 45% on income over £150,000 known as the Additional Rate Band
Note that the personal allowance is reduced by £1 for every £2 that adjusted net income exceeds £100,000, so the effective tax rate of income between £100,000 and £122,000 is 60%. If you include National Insurance that's a tax rate of 62%!
Many companies offer employee benefits which can provide tax advantages. When planning for income tax, these benefits should always be assessed and included in your calculations.
As part of your personal tax planning you should consider either taking advantage of or asking your employer to provide tax free benefits in kind. Often this can make financial sense for both the employee and employer.
Employee benefits which are not subject to tax include:
share incentive schemes
employee pension contributions made by the employer
some uniforms, materials and equipment to do a particular job
some small gifts
training for a degree or qualification
providing a mobile telephone
company parking spaces.
Tax relief on pension contributions, whether by an employee, an employer, or both should also be carefully considered and calculated when income tax planning.
Entitlement to tax relief on pension contributions is dependent on various factors including the scheme, who is making the contribution, an individual's "Net Relevant Earnings" and if they are an Additional Rate Band taxpayer.
Inheritance tax (IHT) is paid on a person’s estate, property, money and possessions, if it is valued above the current threshold of £325,000. The current rate of IHT is 40%, unless 10% of an individual’s estate is bequeathed to charity, in which case the tax rate is reduced to 36%.
Transfers of assets between spouses and civil partners are exempt from IHT, but other lifetime gifts may be more tax-efficient.
Lifetime gifts are potentially exempt from IHT, and there is no limit on such transfers, so this is a useful way to transfer assets that you do not need to keep in your estate. The key to ensuring lifetime gifts do not suffer inheritance tax is surviving 7 years after the date of the gift.
In the event of the donor dying before 7 years have passed there are varying rates of tax applicable ranging from 8% - 40% depending on the number of years which have passed since the gift was given.
There are also anti-avoidance provisions which may negate the gift entirely.
Use of trusts
If your intended recipient of your estate is not, in your opinion, capable or mature enough not to waste the asset you need not wait until you consider them so. Instead, you can take advantage of inheritance tax planning and make use of a trust prescribing how funds can be used and when they transfer to your intended beneficiary, if at all.
Trusts are also a tax efficient way to reduce liability to IHT. There are a number of different types of trust, including bare trusts, interest in possession trusts, mixed trusts, discretionary trusts, settlor trusts, non-resident trusts and accumulation trusts.
Each type of trust is subject to different rates of tax. It is prudent to consult a tax specialist when establishing a trust for IHT purposes in order to determine which type of trust is most appropriate.
Life assurance policies
Life assurance policies (unless designed to cover IHT liabilities) should be assigned during your lifetime so that the proceeds do not form part of your estate on death.
Savings and investments
Tax is not paid on savings which are in tax-free savings accounts.
These tax-free accounts include:
individual savings accounts (ISAs) incluiding the forthcoming Lifetime ISA and Help to Buy ISA.
some National Savings Accounts products such as savings certificates and Premium Bonds.
Anyone aged 16 plus is eligible to open a cash ISA, whereas to open a stocks and shares ISA the lower age limit is 18. ISAs cannot be held on behalf of someone else.
The amount of money which can be saved in an ISA tax-free for 2016/17 is £15,240.
It is possible to save using both cash and stocks and shares ISAs but the annual threshold must not be exceeded.
Capital gains tax
Capital gains tax (CGT) is levied when an individual sells land, property or a business. These assets can be personal or business, however if someone sells their main home it will not be subject to CGT.
For 2016/17 the rates of CGT are 10% and 20% for chargeable gains with the exception of those made on the disposal of residential property that is not eligible for private residence relief.
When calculating CGT losses should be deducted from profits on assets sold that tax year.
The current CGT allowance is £11,100. There are various methods to reduce CGT including:
transferring assets to a spouse or civil partner
selling shares which your spouse or civil partner then buys back
invest in an ISA as ISAs are not subject to CGT
contributing to a pension, can reduce the tax on a capital gain from 20% to 10% as it extends the upper limit of an individual’s personal tax allowance
CGT is highly complex and it is advisable to engage an expert when calculating it.
Retirement planning and pensions
Planning for retirement is important, the first thing anyone should do is work out what income they will need. Income tax is still levied when an individual retires.
Tax is due on personal and company pensions. The personal allowance for the tax year 2016/17 is £11,000 per annum. Any income exceeding the allowance will be taxed.
When withdrawing money from a personal pension pot you can take the first 25% tax-free (the Tax Free Lump Sum).
Other factors affecting your income tax liability
There are many other factors that affect your income tax liability such as whether you operate a sole trade or are a member of a partnership, have invested in a small company and made losses on shares.
At Parkers our ethos is to consider the past, present and future for you and your family. Through this consultative process we can identify key planning opportunities to ensure that you and your family retain as much income as possible.
This guide is of course not an exhaustive list. If you are concerned about personal tax why not take advantage of a free no obligation consultation.