Get your own back on the taxman
Tax is a funny thing. It's not the most interesting topic in the world so we tend to avoid thinking about it - that is, until we realise how much of it we are paying. Why should we pay tax on our savings? Why should we be taxed on our capital gains, and why, why, why should the taxman pocket a chunk of our estate when we die?
Despite this indignation, few of us take action to reduce our tax liability. As a nation, we waste £9.3 billion a year on unnecessary tax, according to the 2008 Tax Action report from Unbiased.co.uk, yet over 80% of Brits admit to doing nothing to try and cut their tax bill.
There are numerous ways to pay less tax and ways in which tax relief and tax credits can work in your favour. Here are some invaluable tips on how to get your own back on the taxman and ensure you’re not giving him more than you need to.
Keep in touch with taxman
He's never going to be your best mate, but it pays to keep in touch with the taxman to ensure you’re paying the right amount of tax. You must inform HM Revenue & Customs of changes in your circumstances - if you get married or divorced, for example. Likewise you’ll need to tell them if you start to receive a second income, or if the amount of your untaxed income increases or reduces.
Your tax-free allowance, also known as your personal allowance, is reduced by a number of factors, including any benefits you get from your employer, such as a company car or private medical insurance.
Your employer should give you a P11D or P9D form detailing the benefits they’ve told HMRC about. You’ll need to keep these details for two years after the tax year they relate to and use this information to fill in your tax return.
It's also important to inform HMRC when you should stop paying tax, such as when you retire, otherwise your savings will continue to be taxed.
Check your taxcode
It’s essential to check you have the correct tax code because you could be paying too much income tax if it’s wrong. You could also be paying too little, but it’s better to set things straight now to avoid complications in the future.
Tax codes are used by employers and pension providers to calculate the amount of tax to deduct from your pay or pension. Tax codes are set by HMRC, based on your taxable income and allowances. HMRC has been known to get tax codes wrong; in fact, it is estimated that one in 10 are incorrect. So look at the code on your P45 or payslip and find out if yours is one of them.
The code should comprise the total figure you are allowed to earn in any tax year before you start paying tax, and a letter. A tax code of 527L means you start paying tax after you have earned £5,270. Further information about different tax codes can be found at Direct.gov.uk.
If you think your tax code is incorrect, contact your local tax office. Should HMRC change your tax code, you’ll receive a ‘notice of coding’ from your tax office. Keep all notice of coding letters for future reference.
Use your ISA allowance
The taxman likes to get his hands on the interest on your savings and the growth on your investments. However, you can avoid this by making the most of your annual individual savings account allowance.
You can save up to £7,200 a year free of tax in ISAs, of which £3,600 can be as cash.
However, according to Nationwide, lots of us are missing out on this lucrative tax break - only a third of Brits currently hold an ISA.
Check your entitlement to tax credits
Tax credits provide financial support to help parents with everyday costs. With nine out of 10 families eligible for either child or working tax credits, it's worth finding out if you can claim.
Child tax credit is a payment to support people with at least one child. The amount you receive depends on a number of factors, including your income. The payment has two elements. The family element which is paid to any family with at least one child and the child element which is paid for each child. Child tax credit is paid in addition to any child benefit.
The working tax credit is financial support for people on low incomes, even if they don’t have children. To claim the working tax credit you must be 25 or over and work at least 30 hours a week, although there are exceptions.
Find out if you are eligible by contacting HMRC on 0845 300 3900. Details are available online at taxcredits.direct.gov.uk.
Check your council tax band
The full council tax bill assumes there are at least two adults living in a property; if you live alone, you are entitled to a 25% reduction.
You may also qualify for the Second Adult Rebate if you share your home with another adult who isn’t your spouse or civil partner and is unable to pay council tax. People whose income and savings and investments are £16,000 or below are entitled to council tax benefit, although the size of the reduction will depend on your circumstances.
It’s also worth checking that your property is in the correct council tax band, because out-of-date property valuations mean thousands of houses are in the wrong band. If you can prove your property is in a higher band than it should be, you can reclaim overpayments, often backdated to 1993 when the council tax system was introduced.
It’s quite a fiddly process and there’s no guarantee the outcome will work in your favour, but if you believe there is an error, it’s worth the effort. Read how to Check your council tax valuation.
Contribute to a pension
Pensions are the most tax-efficient way to save for retirement. This is because the government offers tax-relief on contributions to encourage us to save. According to research from Scottish Widows, a worrying 40% of us aren’t aware that this tax break is available.
This means many savers are missing out on a huge amount of tax relief.
It works like this: for every pound a basic rate taxpayer pays in their pension, the provider will claim tax back from the government at 20%, which means it costs you just £80 to pay £100 into your pension pot.
The same goes for higher-rate taxpayers who receive 40% tax relief on contributions, although it works a little differently. The first 20% is claimed by the pension provider, but you must claim the remaining 20% back yourself when you file your annual self-assessment tax return.
Salary sacrifice is a scheme that can earn you even more tax relief on your pension contributions. It basically involves taking a cut in your salary equal to the amount you contribute to your pension, and your employer pays these contributions into your pension from your pre-tax salary.
Chris Shaw, an independent financial adviser from Beacon Asset Management explains: "If you receive your salary then put a portion of it into your pension as many people do, you’ll get tax relief but you won’t get back the national insurance that has been paid on it. Through salary sacrifice, because you’re giving up a portion of your pre-tax salary, your employer can add your NI savings to your pension pot - equal to 11%. And really generous employers could pay their own NI savings of 12.8% into your pension as well."
Salary sacrifice is beneficial all round as it saves employers and employees money. As yet only a small number of employers run the schemes, but given it can improve your pension and save your employer cash, it’s well worth raising the matter with your HR department.
Inheritance tax planning
IHT of 40% is applied to your estate if the value exceeds the nil-rate band - currently £312,000 2008/09 - when you die.
In his pre-budget report last year, the Chancellor announced new rules to allow spouses and civil partners to make full use of their combined nil-rate bands for IHT. This gives couples £624,000. Of course, couples effectively had this, but what is new is the way the unused nil-rate band from the death of one partner can be transferred and used when the other dies.
With house prices increasing rapidly over the past decade, more and more people are set to bust the nil-rate band, yet only 32% of Brits believe their estate would be liable for IHT, according to a survey by ICM Research for Bradford & Bingley.
There are ways to reduce the amount of IHT you pay. "The simplest method is to give money away," advises Chris Shaw. "Either in the form of gifts or trusts."
You can gift £3,000 each year free of tax for example, and up to £5,000 to someone who is getting married or entering a civil partnership. You can give larger gifts, but they only escape IHT if you survive for seven years after parting with the money - known as potentially exempt transfers.
A trust basically allows you to ring fence a portion of your assets for those who you would like to inherit.
These areas of tax planning are quite complex, so it's worth seeking professional help to ensure you mitigate your tax liability correctly. Find it through the Society of Trust and Estate Practitioners (STEP.org or 020 7838 4885).
Capital gains tax planning
When you make a profit from selling an asset other than your main home, such as shares or a buy-to-let property, the gain is often liable to tax. There are exceptions in addition to your main residence, such as savings and investments held in ISAs and personal items worth up to £6,000.
Everyone has a CGT allowance, £9,200 for the 2008/2009 tax year; any gains above this are taxed at a flat-rate of 18%.
There are ways to mitigate the amount of CGT you pay. The simplest method for a couple is to use both allowances to double the amount of gains before tax is paid.
And, if you are married or in a civil partnership, you can transfer assets to your spouse or civil partner without having to pay CGT. "This is particularly worthwhile for higher-rate taxpayers who can transfer assets to a spouse who pays a lower rate of tax," says Shaw.
Private medical insurance
PMI allows you to skip the NHS waiting list and arrange treatment at a time you choose. With most PMI policies, you pay a monthly premium (the older you are, generally the higher premium) and the policy will then pay out, up to specified cover limits and after an agreed excess, for any treatment you might need. Not all conditions are covered by PMI and you get what you pay for: the more cover you want, the higher your premium will be.
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.
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.
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.
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.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
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.
Child tax credit
A scheme started in 2003 that sought to replace a raft of other tax credits and benefits, the payout depends on the number of dependant children in a family, and its level of income. The amount of credit is reduced as income increases. It is payable to the main carer of a child, usually the mother, and is available whether or not the recipient is working.
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.
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.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.