Cut your tax bill in one day
Whether it's your salary, your profits or your fish and chips on a Friday night, the taxman always takes his share, or does he?
Come Tuesday, six million Brits can expect a letter alerting them to the fact they have under or overpaid tax in the last year.
Around 1.4 million taxpayers will owe an average of £1,500 as a result of administrative error from HM Revenue & Customs, which put them on the wrong tax code. A further 4.3 million people will be due a rebate.
Making sure you don't pay more than you need is important, as with the current budget deficit, we will likely face further tax increases.
In April personal allowances were frozen on income tax and a new 50% tax band came in for earnings over £150,000.
National insurance is set to inch up in April 2011, taking the rate for employee contributions to 12%.
And you could also feel the pinch outside of work, with potential increases on the softer targets of cigarettes, alcohol and fuel.
Here's how you can tackle your taxes and make yourself richer in just one day.
9AM - THE BASICS
The first step is to make sure you're paying the right amount of income tax. Your tax code determines how much income tax you pay, so it's essential it's correct.
If not, you could be paying too much tax – or too little, building up a nasty bill when HM Revenue & Customs spots its error.
Problems with tax codes are particularly common among older people. "More than 40% of the queries we receive relate to tax codes.
"In some cases, it's because the Revenue doesn't add the additional age-related tax allowance; in others, it's because someone has multiple sources of income," says Paddy Millard, chief executive of the charity Tax Help for Older People.
Checking your tax code is fairly straightforward. Ask your tax office for a coding notice or check the code on your pay slip. If you don't think it's correct, speak to your tax office. You can claim back up to six years' overpaid tax, although this will drop to four years in 2012.
Another area where the wrong code can seriously affect your wealth is your council tax. To make sure your band is correct, speak to neighbours and look at historic prices for properties in your street.
Rightmove has a tool to help you find what your home, or ones like it, sold for in previous years.
If you believe your band is wrong, contact your local listings officer through the Valuation Office Agency or the Scottish Assessors Association.
It's also worth checking that you receive all the tax credits you're entitled to. Research by unbiased.co.uk found that around a quarter of pensioners aren't claiming their full pension credits – an equivalent of around £2.4 billion a year going unclaimed.
Likewise, with nine out of 10 families entitled to tax credits (including people without kids), you could be missing out.
To see whether you could claim tax credits, visit Tax Credits Online. Alternatively, use turn2Us.org.uk to check whether you could claim any benefits and tax credits.
10AM - SAVINGS
Once you've sorted the basics, you can turn your attention to making your savings more tax-efficient. A cash ISA works just like a savings account but pays you interest tax-free.
You can currently put up to £5,100 a year into your cash ISA.
"You should put any spare cash into your cash ISA," says Danny Cox, head of advice at Hargreaves Lansdown.
If you're a non-taxpayer and have savings outside a cash ISA, then make sure you register for gross interest with a form R85 from HM Revenue & Customs. Likewise, if you're married, then arrange any savings as tax-efficiently as possible.
Mike Warburton, tax director at Grant Thornton, advises: "Make sure you have all your savings in the name of the spouse who has the lower tax bracket so as to keep the tax bill down."
11AM – INVESTMENTS AND PENSIONS
When it comes to your investments, a stocks and shares ISA is a good option. You can invest in funds or hold assets including shares, corporate bonds and gilts. Each year you can invest up to £10,200, minus any contribution you put into a cash ISA.
In terms of tax, although it's impossible to claim back the 10% tax credit on any dividends, higher-rate taxpayers save paying a further 22.5% tax on the dividend. Additionally, any gains are tax-free.
Pensions, with their tax relief on contributions, are an even more tax-efficient way to save. Tax relief at 20% is available – so for a contribution of £80, the pension company can claim a further £20 on your behalf, making your contribution up to £100.
Higher-rate taxpayers can also claim back a further 20% through their self-assessment. But the government is currently consulting on this and changes may be imminent on tax relief levels.
However, you don't even need an income to get tax relief. A non-earner can pay in up to £2,880 a year and receive £720 in tax relief to bring their total contribution up to £3,600.
If you're married, it's also worth looking at both spouses' pension planning. "If you retire at 65, a couple will have a combined income tax allowance of £18,980 a year.
Rather than lump all the pension savings into one name and only take advantage of half the allowance, spread pensions between you so as to use the full allowance," adds Cox.
When trying to minimise your tax bill, salary sacrifice is worth considering. With this, part of your salary is sacrificed and diverted to a benefit such as a pension, cycle-to-work scheme or childcare vouchers.
The financial results are particularly compelling. For example, an employee earning £30,000 a year sacrifices £1,000 for a pension. This only costs them £690 a year as they would have paid £310 in income tax (£200 at 20%) and national insurance (£110 at 11%).
Additionally, it saves the employer national insurance at 12.8%, equivalent to £128, which the employer could add to the employee's pension. This would give them a contribution of £1,128, for a cost of just £690 to the employee.
For those earning over £100,000 salary sacrifice is also attractive, because although the 50% tax band kicks in at £150,000, the personal allowance is reduced at the rate of £1 for every £2 once taxable earnings hit £100,000.
Patrick Murphy, a certified financial planner with Bluefin Advisory, explains: "This effectively creates a tax band of 60%. If someone earning £100,000 is offered a pay rise of £4,000, this £4,000 is only worth £1,600 after tax.
"By sacrificing the pay rise and redirecting it into their pension they get a £4,000 pension contribution that only cost them £1,600. It's a bit of a no-brainer really."
Also think about timing when you take your state pension as this could affect your tax bill. Millard explains: "You can defer when you start claiming and either take an enhanced pension or a lump sum and a standard pension.
If you take a lump sum, this is taxed at your marginal rate, so you could wait until you are on a lower tax band to reduce your tax bill."
BREAK FOR LUNCH
Even at lunchtime you can save on tax. VAT is charged on pre-packed food such as crisps, chocolate and drinks; any hot food you buy; and on anything you eat in.
Cold sandwiches and other takeaway food are zero-rated, so choosing these will mean a few less pennies going into the taxman's coffers.
Find out more about cutting the cost of food
2PM - INHERITANCE TAX
At 40% on anything over the inheritance tax nil-rate band (currently £325,000), it's wise to spend time ensuring you avoid leaving an IHT bill.
It's a little easier for married couples as they can take advantage of the transferable nil-rate band, with the widow or widower being able to carry forward any of their spouse's unused nil-rate band to use when they die.
"Unless you have well in excess of this, the best way to reduce a liability is to take advantage of the IHT-exempt gifts," says Cox.
These include gifts worth up to £3,000 in each tax year; as many gifts of up to £250 a year as you like; wedding gifts (£5,000 for children, £2,500 for grandchildren and £1,000 for anyone else); gifts to charities, museums or UK political parties; and gifts out of your income.
This last gift is often overlooked but as long as it's taxed income, if you give the gift on a regular basis – and by doing so you don't affect your standard of living – you can give away as much as you like and it's immediately outside your estate.
Another way to cover a future liability is by taking out life insurance to ensure there's money available to pay it. If you do, or you have any other life policies in place, make sure you write it in trust.
Tim Schofield, a broker at IFA Alexander Forbes, adds: "This ensures the proceeds are paid to a person rather than going to your estate." It's easy to arrange a trust: simply contact your life insurer and it will arrange it for you.
4PM - CAPITAL GAINS TAX
Make a profit and the taxman will want his share, charging capital gains tax (CGT) at 18% on any profits above £10,100 for basic-rate taxpayers and 28% for higher-rate taxpayers (as of 22 June 2010). Thankfully, a little bit of planning can help you avoid a bill.
"Use your own CGT allowance by selling assets with profit up to your allowance each year," says Warburton, "and if you have a spouse, you can transfer a liability to them to use their allowance too."
Investing in products that are CGT-efficient can also help. These include ISAs, pensions and venture capital trusts, which are all CGT-free, and EISs, where gains become tax-free after three years.
It may also be worth crystallising any losses you've made as these can be rolled forward for when you do make gains in the future. Schofield explains: "If you're sitting on a loss, it might be sensible to sell the investment and realise the loss.
You can reinvest in the same investment after 30 days or straightaway if you invest in something else, but the loss can be carried forward indefinitely and used against a future gain that's above your annual allowance."
For example, if you've made a £30,000 loss on your investments, sell them and notify the taxman of your loss through your self-assessment form.
This can be carried forward until you sell your investment, which has a £40,000 gain. Then, by using your annual allowance and the loss, there will be no CGT to pay.
6PM - TIME TO RELAX
Once you've followed these simple steps, all you need to do is to put your feet up and calculate just how much money you've managed to save in the space of just one day.
A tax-efficient way of receiving staff benefits, where an employee agrees to forego a proportion of their salary for an equivalent contribution into their pension scheme or in exchange for company car, gym membership, childcare vouchers or private medical insurance. A salary sacrifice scheme is a matter of employment law, not tax law, and is often entered by an employee who is about to move into the higher 40% tax bracket.
A scheme originally established in 1944 to provide protection against sickness and unemployment as well as helping fund the National Health Service (NHS) and state benefits. NI contributions are compulsory and based on a person’s earnings above a certain threshold. There are several classes of NI, but which one an individual pays depends on whether they are employed, self-employed, unemployed or an employer. Payment of Class 1 contributions by employees gives them entitlement to the basic state pension, the additional state pension, jobseeker’s allowance, employment and support allowance, maternity allowance and bereavement benefits. From April 2016, to qualify for the full state pension, individuals will need 35 years’ of NI contributions.
Generally thought of as being interchangeable with life assurance, but isn’t. Life insurance insures you for a specific period of time, at a premium fixed by your age, health and the amount the life is insured for. If you die while the policy is in force, the insurance company pays the claim. However, if you survive to the end of the term or cease paying the premiums, the policy is finished and has no remaining value whatsoever as it only has any value if you have a claim. For this reason, life insurance is much cheaper than life assurance (also called whole of life).
Used by an employer or pension provider to calculate the amount of tax to deduct from pay or pension. A tax code is usually made up of several numbers followed by a letter. If you replace the letter in your tax code with ‘9’ you will get the total amount of income you can earn in a year before paying tax, for example 747L would mean a person could earn up to £7,479 before paying tax. The wrong tax code could mean a person ends up paying too much or too little tax.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
A special government scheme operated through employers that allows you to pay for childcare from your PRE-tax salary. The vouchers cover childcare up to 1 September after your child’s 15th birthday (16th if they are disabled) and can be used at any registered and regulated nursery, playgroup and for nannies, childminders or au pairs.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.