If your taxable income is more than the basic rate threshold of £50,270 in 2021/22 then you will likely be paying 40% tax on some of that income (32.5% if it’s dividend income). So, how can you reduce that tax bill?
1. Make pension contributions
The most effective way of saving yourself some tax is to increase the basic rate threshold that applies to your income, and one of the best ways to do that is to make some pension contributions.
In most cases, your pension contributions will receive basic rate tax relief at source. This means that for every £120 you contribute to your pension, you are treated as though you contributed £150 and received 20% tax relief of £30. That £30 is paid directly to your pension rather than being returned to you.
This works fine if you are a basic rate taxpayer, but what if you pay tax at higher rates? Are you missing out?
The answer to this is no; you can receive tax relief at 40% on your pension contributions. This is achieved by increasing your basic rate threshold by the amount of the gross contribution you have made – in the example above, by £150.
The effect of this increase is that you then pay basic rate tax on more of your income. Instead of paying 40% tax on that £150 (£60) you only pay 20% tax (£30) saving yourself the difference of £30.
So, when you make a contribution of £120 to your pension:
- The pension receives your £120 contribution
- The pension also receives the basic rate tax relief amount of £30
- You receive the additional higher rate relief of £30
In a nutshell, your pension pot has received £150 but your net contribution, after tax relief, is just £90.
More good news is that pension contributions are also deducted from your income when determining if you exceed the £50,000 income limit for repayment of child benefit, so if you are only just over that income limit you can use pension contributions to bring your income back down so that you don’t have to pay that High Income Child Benefit Charge.
Pension contributions can also be used to bring your income below the £100,000 income threshold at which the personal allowance starts to be withdrawn.
There are a number of factors that can affect the amount of pension contributions you can make and you should speak to your financial adviser, accountant or tax adviser about this.
2. Make charitable donations
Tax relief on eligible charitable donations works in exactly the same way as for pension contributions set out above, as long as you claim gift aid when making your donation.
You receive 20% tax relief at source which is paid directly to the charity, and higher rate relief by increasing your basic rate threshold.
So, when you make a donation of £120 to an eligible charity:
- The charity receives your £120 contribution
- The charity also receives the basic rate tax relief amount of £30
- You receive the additional higher rate relief of £30
In a nutshell, your chosen charity has received £150 but your net donation, after tax relief, is just £90.
Charitable donations can also reduce your income for the High Income Child Benefit Charge and the £100,000 threshold.
3. Make tax-efficient investments
The Enterprise Investment Scheme (EIS) provides an opportunity to subscribe for shares in a company and receive income tax relief of 30% on the amount invested. An investment of £100,000 can therefore provide you with a tax repayment or reduction of £30,000.
Unlike pension contributions which only provide tax relief in the year they are made, the EIS investment can be carried back and provide tax relief for the previous year.
It is also possible to defer capital gains tax by investment into EIS shares, and to dispose of the EIS shares themselves with no capital gains tax to pay.
There are, of course, a number of conditions to be met for the investor, the investee company and the shares themselves in order for the income tax and capital gains tax reliefs to be obtained initially and retained going forwards.
4. Tell HMRC that you want to claim relief
If you are already within self-assessment then the above reliefs can all be claimed through your self-assessment Tax Return.
If you are a PAYE employee who doesn’t complete a Return then HMRC can’t give you the relief if they don’t know about it!
Although it is possible to adjust your PAYE code to have tax repaid through your salary, if contributions or investments are irregular then it’s likely to be more straightforward and easier in the long run to register for self-assessment and claim reliefs by completing a tax return.
What’s right for you will depend on your circumstances so discuss this with your tax adviser or accountant.
For more advice, please get in touch with us today.
