As the cost of living crisis continues, making the most of your tax-efficient allowances is vital. Learn about the unmissable tax breaks you could use this year.
Last month, you learned about the chancellor's big freeze in tax allowances that will remain in effect until 2026. These freezes may have an impact on how much tax you pay, so it’s important to understand how they will affect your wealth directly.
On a more positive note, there remain key allowances that you can use, in order to minimise your tax liability and save for your future.
Considering the UK’s current cost of living crisis, exemplified by inflation reaching a 40-year high, it could be that you are searching for ways to mitigate your tax bill. If so, it is essential that you understand the tax breaks available to you – and we can help.
Especially if you are self-employed or a high earner, it is crucial to understand the tax reliefs and allowances you can access through self-assessment that may help you save money.
Read on to find out about key tax-efficient allowances you could use in this and future tax years.
Pension tax relief: 3 key allowances and reliefs to understand
1. The Annual Allowance
The Annual Allowance refers to the amount you can pay into your pension each year without incurring a tax charge. You can carry forward any unused Annual Allowance from the past three tax years, meaning you may make the most of your accumulated allowance if you haven’t in the past.
The Annual Allowance stands at £40,000 (or 100% of your earnings, if lower) for most people. However, your Annual Allowance may be lower than £40,000 if you:
· Have a “threshold” income of more than £200,000 a year and have an “adjusted income” of more than £240,000 a year
· Flexibly access your defined contribution pension.
If you are in the above category of high earners, your tax-efficient pension contributions are tapered.
This is called the “Tapered Annual Allowance”, and can reduce your tax-efficient pension contributions to a minimum of £4,000 a year. If you are a high earner, it may be constructive to discuss your own Tapered Annual Allowance with your Kellands financial planner.
If you have begun flexibly accessing income from your pension, you may have triggered the Money Purchase Annual Allowance (MPAA). Once the MPAA is triggered, your Annual Allowance is reduced to £4,000 a year, rather than £40,000.
By understanding and making the most of your Annual Allowance, you could tax-efficiently invest in your future life while mitigating your tax liability.
2. The Lifetime Allowance
As you read last month, the pension Lifetime Allowance (LTA) is the amount a person can save into their pension tax-efficiently over the course of their lifetime.
The LTA will now remain at £1,073,100 until 2026, rather than rising in line with inflation.
This is a crucial allowance for any pension saver to understand, especially if you are a high earner. If your pension exceeds the LTA, you could be subject to a 55% tax charge when you withdraw a lump sum upon retirement, or a 25% tax charge if your pension is taken as income. Plus, you’ll also pay Income Tax at your marginal rate.
So, while making the most of your Annual Allowance, it is paramount that you discuss your pension’s proximity to the LTA with your financial planner. This way, you can explore alternative savings options if your pension is likely to exceed the LTA in the coming years.
3. Additional tax relief for high earners
Basic-rate taxpayers receive 20% tax relief on their pension contributions, helping to lessen their Income Tax bill each year.
Higher- and additional-rate taxpayers can claim an additional 20% and 25% relief respectively – but this needs to be done through self-assessment.
Indeed, many employed high earners assume that their additional relief will be automatically applied through PAYE, but this is not the case. Even if you are employed, high earners should complete a self-assessment form to claim the additional 20% or 25% relief.
If you are self-employed, regardless of your tax band, it is important to understand that you may be able to claim up to 45% tax relief on contributions into your private pension.
Contact your Kellands financial planner for a review of your pension tax relief opportunities.
Your ISA allowances can help save Income Tax and Capital Gains Tax
Individual Savings Accounts (ISAs) are not tax-free, but they do act as a “tax wrapper” that allows you to potentially grow your savings without incurring a higher tax bill.
You could use your ISAs as an additional savings pot for retirement, or to help adult children buy their first home, for example.
Across all the ISAs you hold, the annual contribution allowance stands at £20,000 as of the 2022/23 tax year.
Crucially, any profits you earn from your ISAs aren’t subject to Income Tax or Capital Gains Tax (CGT). This means that you could invest up to £20,000 a year tax-efficiently, without increasing your tax liability if you see positive returns on these investments.
Whereas, you could pay CGT or Dividend Tax on profits you generate or dividends you receive from stocks and shares held outside an ISA. So, it could be wise to make the most of your ISA allowances in each year if you are searching for ways to mitigate tax.
Your Kellands financial planner can offer a bespoke review of your personal allowances
It is important to remember that these are not the only allowances available to you, and that everyone’s circumstances are unique. You can read more about ways to mitigate tax, such as Inheritance Tax (IHT), on our website.
While some allowances are fixed, others vary depending on your situation. If you want to learn about how to use your allowances and reduce your tax bill, your Kellands financial planner is your first port of call.
We can help assess how you can make the most of your tax-efficient allowances and reliefs in this and future tax years.
Get in touch
Email us at firstname.lastname@example.org, or call 0161 929 8838.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Your pension income could also be affected by the interest rates at the time you take your benefits. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.