How to pay less tax in the UK

Saving Taxes

Please note that I am not an accountant or lawyer and this article doesn’t represent financial advice. Always seek the help of a professional regarding your specific financial situation

Tax is a complicated subject. It funds our roads, hospitals, schools and other essential services. To make it clear, I am in favour of everyone paying their fair share. However as a UK tax resident there are a number of government schemes available to help reduce your tax burden legally.  The focus of this article is for those that are working as a PAYE (Pay as you go) employee. That is, those employed by a company.

Read on to discover my tips on how I pay less tax in the UK

ISA ISA ISA!!

The ISA scheme I think has to be one of the best schemes for investing and wealth creation in the UK. I feel like this is a scheme that will be eventually reduced or removed altogether as it’s quite a generous allowance for the average person.

Basically an ISA is a tax free wrapper which allows you to invest up to £20,000 per financial year in either shares or a cash savings account. Any capital gain or dividend paid from the companies inside this ISA is tax free for life. How good is that!!

So one strategy I am looking to employ is to try max out my and my partner’s ISA each year by investing into ETFs. 

The goal of this would be to grow the investments to a point where we can draw out an income through selling small parcels of shares each year or living off the dividends. The fact that these are tax free also has a huge benefit for those who are paying upwards of 40% tax as you are effectively getting 40% more income from the dividends or gains due to them being tax free.

As well in the UK, there are ETFs you can purchase that generate as much as a 6% dividend yield such as The ISHARES UK DIVIDEND UCITS ETF.

My strategy is to invest into growth companies and ETFs to get a higher return and once I start wanting to draw down from the capital I will switch the investments to something paying a higher dividend such as the ETF above.

Capital Gains Allowances

In the UK the government allows you to also have up to £12,300 in capital gains per year without paying any tax. So a simple strategy if you haven’t used up your ISA allowance would be to sell some of your holdings outside the ISAs up to the £12,300 and then invest this back into your ISA account.

This is quite a good strategy for crypto holdings if you want to sell as there are no ISAs that support crypto trading (yet!)

Tax on Dividends

If you want to pay less tax in the UK you are given a dividend allowance of £2000 per year. So if you have some of your income generating assets outside of an ISA it is worth ensuring these only generate up to £2000 per year and if it’s more you can move them inside your ISA.

Side Hustles

The UK government introduced a scheme in 2016/2017 which means that sole traders who earn £1000 in additional income don’t need to declare this or pay any tax on this. You don’t also need to register as a self-employed person with HMRC if your income is less than this. 

So for anyone who is a higher income taxpayer this is quite lucrative and £1000 can easily be earned online these days or through some additional work.

Example:

Jane earns £55,000 from her job. If she got a pay rise in her job to £56,000 the extra £1000 she earns will be taxed at 40% leaving her with £600 after taxes for this extra amount.

However, if she earnt this £1,000 through a side hustle outside of her PAYE employment she wouldn’t pay any tax so would pocket the full £1,000.

Salary Sacrificing / Contributing extra into Pension

For the vast majority of UK taxpayers this is the most effective strategy as this is an easy way to reduce the income tax you pay on your salary. The UK government has made it very favourable to taxpayers to build up a pension pot outside of tax.

Contributions made from your salary into your pension are free from any tax. So depending on your marginal tax rate you can earn an instant 20% return if you are a basic rate tax payer, 40% return if you are a higher rate taxpayer and 45% if you are an additional tax rate payer.

This is huge! Imagine getting a risk free return of 20-45%. Not to mention this amount will compound over the duration of your working life.

The only catch?

You can’t access the money until you are 55 (57 from 2028)

However there is a £40,000 annual allowance for your pension contributions so if you are looking to build up wealth for your retirement or you are already close to retirement age this is the most effective way of reducing tax whilst building wealth.

For me I haven’t been super aggressive at building up my pension pot because I intend to retire in some capacity by the time I am 40. However for the average joe in the UK this is such an easy win.

The only other thing to note about pensions is that when you reach 55 you can take out 25% tax free but the rest are taxed at your normal rates. So whilst you are not taxed on the way in you might be taxed on the way out.

Do you have any other strategies or ideas of how you currently reduce your tax burden?

Let us know in the comments 🙂

My Money Tree

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