Tax is boring. I know. This is the second Tax post in the last couple of weeks. But it’s important!
Understanding the various tax-efficient earning, saving and investing approaches is a way to accelerate your financial independence. The UK provides a great environment for tax-efficient earning, saving and investing.
In the UK, everyone is entitled to earn a certain amount of money without paying tax on those earnings. This is called the Personal Allowance.
The Personal Allowance for 2019/20 is £12,500. This means the first £12,500 you earn in the year is completely tax free.
The Personal Allowance is considered the first tax band, the nil rate or 0% band
Your Personal Allowance can go up and down depending on your tax situation. Some Taxable Benefits reduce your Personal Allowance. Some Tax Rebates or other Allowances increase your Personal Allowance.
Reducing your Personal Allowance:
- Taxable benefits from your work, like Private Health Care
- Earning over £100K
- Previous year(s) underpayment of Tax
Increasing your Personal Allowance:
- Allowable expenses, like if you work from home
- Relief from Pension Contributions
- Marriage Allowance
- Some benefits, i.e. Blind Person’s Allowance.
- Charitable Donations via Gift Aid
- Previous years(s) overpayment of Tax
What are the other Allowances?
There are other Allowances that enable you to earn without paying tax. In some cases, you will need to contact HMRC or complete a Self Assessment to benefit.
Check gov.uk for more information, or consult an accountant.
Here is a non-exhaustive list of other Personal Tax Allowances:
- Personal Savings Allowance
- Individual Savings Account Allowance
- Dividend Allowance
- Trading Allowance
- Property Allowance
- Rent a Room Scheme
- Pension Allowance
- Marriage Allowance
- Capital Gains Allowance
What is the Personal Savings Allowance?
The Personal Savings Allowance allows you to earn up to £1,000 tax free interest.
If you are a ‘higher-rate’ taxpayer, this is reduced to £500. If you are an ‘additional-rate’ taxpayer this is reduced to £0.
Some taxable accounts now pay better interest rates than Individual Savings Accounts (ISAs). This is especially the case with introductory offers. It can make sense to have some funds in taxable accounts. If you are a basic-rate taxpayer, you can earn up to £1,000 before paying any tax on that interest. If you earn more than £1,000 you then start paying tax on any interest earned above £1,000.
Any interest earned in an ISA is tax free.
What is the Individual Savings Account Allowance?
You can save or invest £20,000/year in an Individual Savings Account.
You do not receive tax relief when you contribute, so the £20,000 will come from your net pay.
However, all earnings and growth within an ISA are completely tax free.
ISAs are too big of a subject to cover here. I will cover ISAs in a future post.
What is the Dividend Allowance?
In 2019/20 you can earn £2,000 per year from Dividend from company shares before paying any tax. https://ift.tt/1nef4py
There are also different bands for dividends. What you will pay will depend upon your Income Tax Band, but the rate is different for Dividend tax.
| Band | Tax rate on dividends over your allowance |
|---|---|
| Basic rate | 7.5% |
| Higher rate | 32.5% |
| Additional rate | 38.1% |
Any dividend earned within an ISA is tax free.
What is the Trading Allowance?
Everyone is able to earn £1,000 tax free from ‘Trading’. Not Bitcoin or Stock trading! Self-employment, casual services, or hiring out equipment or tools you own.
This is ideal if you are bootstrapping a self-employment side business in your own time. You can earn £1,000 without even informing HMRC. Allowing you to get the business off the ground before worrying about tax!
If you earn over £1,000 from self-employment or casual services you need to inform HMRC. More information is available on gov.uk
What is the Property Allowance?
You can earn £1,000 per year tax free from property or land income. The obvious is buy-to-let, but other tax changes has made buy-to-let less attractive. You can earn income from land, such as renting out your driveway as parking.
Some exclusions apply. Especially if you have earnt property or land income from a company.
What is the Rent a Room Scheme?
The Rent a Room Scheme allows you to earn a whopping £7,500 tax-free from income from letting a room to a lodger in your home. Or £3,250 if you share the income with a partner or spouse.
You can also use this scheme if you run a B&B or Guest House.
Bringing in a lodger is not for everyone. If you can manage the disruption, you can earn quite a sum tax-free.
What is the Pension Allowance?
The Pension Allowance is a great retirement saving benefit. It’s one of the reasons the UK is an amazing place to live if you are planning to retire early.
If you earn less than £110,000 per year, you can invest the full £40,000 per year in your pension completely tax free.
You won’t be able to access this money until you retire - currently, the earliest is at age 55, but this may increase. The Pension Allowance is a solid way to build your retirement savings in a tax-efficient way.
If you earn over £150,000 per year your pension allowance starts to taper down to £10,000. This will only affect you if you are a very high earner.
What is the Marriage Allowance?
If you are married or in a civil partnership and your spouse or partner earns more than you, you can transfer £1,250 of your personal allowance to them. This is called the Marriage Allowance.
You cannot do this if your partner earns the ‘higher rate’ of tax.
This tends only to be a gain if you earn less than £12,500 and your partner less than £43,430 in Scotland, or less than £50K elsewhere in the UK. It’s a gain of around £250 per year.
What is the Capital Gains Allowance?
Capital Gains Tax (CGT) is payable if you sell (‘dispose’) something (‘an asset’) that has increased in value.
Disposing of an asset includes:
- selling it
- giving it away as a gift, or transferring it to someone else
- swapping it for something else
- getting compensation for it - like an insurance payout if it’s been lost or destroyed
Say I buy a painting at the local gallery for £7,000. Years later I sell it for £25,000. It was a good painting. I’ve had a Capital Gain of £18,000. You have a Capital Gains Tax Allowance of £12,000. So only £6,000 is taxable.
You do not pay Capital Gains Tax on:
- Your main property, unless you have used it for business reasons or let it out.
- Gifts you make to your spouse or partner
- Personal possessions worth less than £6,000
- Assets held in an ISA
- UK government gilts and Premium Bonds
- Any betting, lottery or pools winnings
For most, holding shares in an ISA or SIPP means you are not liable to capital gains tax. Given the threshold, you have to be disposing of quite a large asset in the year to be hit by CGT.
What could I earn Tax Free?
You can make tax-free earnings in the UK by combining these allowances:
- £12,500 Personal Allowance
- £1,000 Personal Savings Allowance
- £2,000 Dividends Allowance
- £1,000 Trading Allowance
- £1,000 Property Allowance
- £7,500 Rent a Room Scheme
- £40,000 Pension Allowance
- £1,250 additional Personal Allowance from Marriage Allowance
- £12,000 Capital Gains Allowance
Remember that interest and dividend earned in an ISA is completely tax-free!
Letting a room in your house, renting out your driveway, or a weekend side business is a great way to increase your income!
Subscribe now, follow me on Twitter @moneymagery, stick by your principles and you’ll be mortgage-free in no time.
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