Every penny we earned during the first five months of this year effectively went to pay government levies – but millions of people in Britain could have saved a fortune by indulging in some completely legal and relatively straightforward tax-planning techniques.
The Treasury expects to rake in £589bn in the current tax year with income tax (£158bn) and national insurance (£101bn) among the most lucrative.
But tax experts and independent financial advisers insist many people are actually paying far too much tax with Unbiased.co.uk, the professional advice website, estimating that £148m alone will have gone out in unnecessary capital gains tax payments.
Such figures illustrate how much there is to do when it comes to protecting our income and assets, according to Karen Barrett, the site's chief executive, who points out that a bit of planning can result in all of us having considerably more money in our pockets.
"Making use of tax-efficient strategies can make a huge difference and it's important for people to think about how they can make the most of their allowances – which so many taxpayers waste each year – as well as reducing their liability," she says.
1. Check your tax code – and claim what you're due
This has to be your first step. Check with the Inland Revenue to make sure you are on the right tax code and get in contact with your local Citizens Advice Bureau to see if you are receiving the full range of benefits to which you are entitled.
2. Income Tax
Husbands and wives (as well as civil partners) are taxed independently so each will have their own personal allowances and subsequent bands. Therefore, if one partner has a different tax rate to the other it's worth considering moving assets to the lower tax payer to reduce the overall tax burden, points out Geoff Penrice, an independent financial adviser with Honister Partners.
He cites the example of a couple, one of whom is a non-tax payer and one that pays the higher rate. "If they have £100,000 on deposit paying three per cent interest – £3,000 a year – this would be subject to 40 per cent tax in the higher taxpayer's name, which would be £1,200," he says. "If this was transferred to the non-taxpaying partner this would reduce to zero. If they had sufficient capital it is possible for them to save around £17,000 by rearranging their finances."
3. Capital Gains Tax
You can realise up to £10,600 of gains this tax year without having to pay capital gains tax. So if, for example, you have an investment portfolio containing gains of more than that amount consider selling investments to strip out gains within this year's allowance, says Justin Modray, founder of website Candid Money. "Doing so could reduce the amount of tax, if any, you end up paying in future," he says. "If you wish to repurchase the same investments you'll have to wait 30 days, but you can purchase other investments straight away."
If you're married or in a civil partnership, don't forget to use your partner's allowance, too, says Mr Modray, as you can transfer assets to them free of tax, which they can then sell to realise a gain within their allowance.
"Anyone that has realised a loss, either this year or previously, can offset it against any gains," he adds. "Unused losses can be carried forward indefinitely, but you must inform HMRC of the loss within five years from the 31 January after the tax year in which the loss occurred."
4. Individual Savings Accounts
Individual Savings Accounts (ISAs), which were introduced by the Labour Government back in 1999, should be a priority for anyone with money to save because they are the simplest way to make money without sharing any profits with the Treasury.
ISAs can be split into two distinct camps: cash ISAs and stocks & shares ISAs. Cash ISAs are basically tax-free savings accounts on which interest is paid on a regular basis. Stocks & shares ISAs, meanwhile, invest in assets such as open-ended investment companies and investment trusts. As they are exposed to stock markets, the value of investments can rise and fall.
It is important to make sure you use your ISA allowance wherever possible, even if you only have cash savings, advises Patrick Connolly, head of communications at AWD Chase de Vere. "You can currently invest up to £5,340 each year into a Cash ISA and this will mean that all interest is tax-free and it doesn't need to be declared on your tax return," he says. "You should also look at using your stocks and shares ISA allowance into which you can invest up to £10,680 each year (although this includes whatever you invest into a Cash ISA). ISAs are particularly tax efficient for higher-rate taxpayers and often for fixed interest rather than equity investments.
5. Pension benefits
Pension contributions benefit from income tax relief – a £100 contribution costs a 20 per cent taxpayer £80; a 40 per cent taxpayer £60 and a 50 per cent taxpayer £50 – and this makes them particularly attractive, according to Justin Modray at Candid Money.
"If you belong to a company pension scheme then contributions are usually made directly from your pay before tax, so you enjoy the full benefit straight away," he says. "Otherwise basic-rate tax relief is given automatically at source while higher-rate taxpayers can deduct the additional higher-rate tax from their tax bill. You can invest up to your annual earnings, subject to a limit of £50,000."
It can be even more tax efficient to make pension contributions through your employer using salary sacrifice, according to Patrick Connolly at AWD Chase de Vere. "This is a contractual arrangement where you give up part of your cash remuneration and in return receive an equivalent value of non-cash benefits," he explains. "Pension contributions through salary sacrifice benefit from tax relief at source on contributions, no National Insurance payments on contributions and the possibility that your employer may boost the pension contribution by adding part or all of their National Insurance saving.
6. Inheritance tax
Your first task should be to write a will. This may not save inheritance tax on its own but it will force you into working out exactly what assets you will leave behind. This list can include everything so make sure to factor in the threats to your life such as the cost of long-term care.
When you have a total figure, compare it to the estimated value of your assets – remembering to add in your house, savings and investments – to provide an estimate of what you may end up leaving to friends and family.
If this figure is over £325,000 – the current threshold – then it is time to think about getting your assets out of reach of the Treasury's grasp.
There are plenty of allowances around IHT that are not being utilised, points out Geoff Penrice at Honister Partners, including a £3,000 annual gift allowance and gifts out of income. In addition, there are some very useful trust options for tax planning purposes.
"I like 'Discounted Gift Trust', which allows someone to gift capital into a trust – such that the capital falls out of their estate after seven years – but enables them to still receive an income for life," he explains. "This is particularly useful when someone has surplus capital, which they will not need, but requires access to the income which the capital produces."
There are also Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs) – but these aren't for everybody, warns Mr Connolly. "Investors get a range of benefits – including 30 per cent initial income tax relief – but they are usually risky investments so there is a danger you could lose more than you gain," he says. "Such products are therefore only usually suitable for wealthier investors who already have other investments in place."
Enterprise Investment Schemes, says Mr Modray, "are similar to VCTs in that your money must be invested in very small companies, but arguably even higher risk as your money is invested in the shares of single companies rather than a fund.
"An income tax rebate of 20 per cent is given on investments of up to £500,000, provided the shares are held for at least three years."
Higher-rate taxpayers who would rather give money to charity than the taxman should consider making a donation, adds Mr Modray. "When you make a donation through the Gift Aid scheme the charity can reclaim basic rate tax," he explains. "You can then reclaim the additional higher rate tax via your return. For every £100 donated a higher rate taxpayer can reclaim £25."
Tax freedom day
* Britons worked 149 days to pay their taxes in 2011 – three days longer than in 2010. However, there are regional differences with Londoners having to work the longest to pay off their income tax burden (151 days) while the Welsh spend the least time paying their income tax (135 days).Reuse content