Tax planning: The complete guide to tax mitigation

Tax planning

Are you paying more tax than you really should be?

We all owe a fair share to society, but you and your loved ones shouldn't be left worse off due to poor organisation.

This is where tax planning can help. By making the most of your allowances, reliefs and relevant tax rules, it is possible to put £100s, £1,000s, or more back into your pocket each year.

The purpose of this guide is to give you a fundamental understanding of how tax planning works, and how you can use it for your own financial plan.

You will also find text links to research and blogs that will provide further reading and lots of hints, tips and ideas.

We will continually be updating this page, so it's definitely worthwhile bookmarking it for future reference.

What is tax planning?

Making your financial plan as tax-efficient as possible

Could some of the tax you are paying now be put towards your retirement instead?

If you're a business owner, could you increase your take-home pay by changing your salary-dividend balance?

Might there be a way to pass on more wealth to your loved ones when you die, without paying so much inheritance tax?

These are the kinds of questions that tax planning seeks to address. Tax planning aims to enhance the efficiency of your financial plan by restructuring where needed to minimize unnecessary tax exposure.

The UK tax system is complicated, often leading to intimidation and apathy (which, in turn, lead to overpaying). Yet it does not have to be this way.

With good financial advice, it is possible to reduce a tax bill legitimately - and also gain great satisfaction and peace of mind from doing so.

KEY INFO

Which taxes do I need to consider?

A multi-pronged strategy to deal with a myriad of taxes.

Many taxes exist in the UK. After all, there are many ways to generate income and wealth.

Decisions taken to reduce one tax often have knock-on effects on your wider financial plan, and can impact the other taxes you pay. This is why a carefully planned multi-pronged strategy is needed.

Here is a summary of the main taxes to consider for a financial plan:

Income tax (on your salary)
Capital gains tax (on your investments)
Tax on savings interest
Dividend tax
VAT (value added tax)
Stamp Duty
Inheritance tax
Pension-related taxes (such as exceeding your Lifetime Allowance)

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Who needs tax planning?

The more assets and income you accumulate, the more tax planning is needed.

As you start out in your career, your main tax concern is likely to be income tax on your salary. However, things get more complicated as your earnings go up, you get on the housing ladder and start building up some investments.

For business owners, the tax landscape is usually even more complex. On top of the above you also have corporation tax, dividend tax and Business Asset Disposal Relief on capital gain tax if you decide to sell your business.

Taxes become more intricate still when you start thinking about your pension (where tax relief is involved). As you eventually enter retirement, the question of inheritance tax also typically presses harder on people as they wonder how they can leave a meaningful legacy behind them.

In short, almost everyone with income and assets needs tax planning. As these diversifying assets grow, moreover, the need typically becomes greater to ensure you are not overpaying.

Key info

Where do you start?

List your present and projected assets and income streams.

To start tax planning, you can ask yourself what you currently own (that’s of value) and where you generate an income.

For instance, your assets might include stocks and shares, bonds, cash savings, cars, jewellery, cryptocurrency, property, businesses and pension savings/investments.

Your income streams may comprise your salary, dividends, self-employed (or freelance) income, rental income from tenants, pension income and royalties (e.g. from book/music sales).

With a clearer picture of your assets and income, it becomes easier to identify which taxes may affect you and how you can start planning for them.

You can also project how these might develop and expand in the future, to give you an idea of which taxes may affect you. This can help you develop a long-term tax mitigation plan.

Making use of allowances

Get the most out of what you can generate each year, tax-free.

Each financial year (April-April), UK residents are entitled to a set of tax-free allowances.

One of the best ways to save on a tax bill is to make the most of these allowances. After all, for the vast majority of them, you can't “carry over” any unused allowance to the next year.

For instance, you could minimise a capital gains tax (CGT) bill by spreading your asset sales across multiple tax years.

You are allowed to generate up to £12,300 in capital gains (outside of an ISA) each financial year, tax-free.

So, if you wanted to sell assets with £25,000-worth of gains and can wait, then you could eliminate the CGT bill entirely by selling some of them in one financial year and the rest in the next.

TAX PLANNING

Using an ISA strategically

Where your allowances run out of steam, the ISA is your friend.

An ISA is a type of savings (or investing) account that you never have to pay tax on. Any capital gains, interest or dividends you generate within an ISA will be tax-free.

You can put up to £20,000 into your ISAs each financial year. Once the year is over, however, you lose any unused allowance. So it’s worth getting the most out of it where possible.

One good strategy is to use your ISAs shrewdly alongside your annual allowances.

For instance, if you see yourself selling a second home in the future (hopefully releasing a capital gain), then this would likely use up your CGT allowance for the financial year. If you also then sell some shares for a profit (in a general investment account) in the same year, then these would be subject to CGT.

However, if the shares are contained within an ISA instead (e.g. a stocks and shares ISA), then these could be sold without attracting CGT.

You might also consider focusing an ISA portfolio on shares which you intend to hold for a long time and later sell for a profit.

Dividend-producing shares could then be held outside of your ISA if your ISA allowance is used up. This is because, after CGT and dividend annual allowances are fully utilised, dividend tax rates are lower than CGT rates for basic rate taxpayers in 2021-22.

For higher rate and additional rate taxpayers, however, bear in mind that your dividend tax rate is at least 32.5% in 2021-22, which is more than the CGT you pay on the profits of disposed assets (20%) and property (28%).

Transferring assets

Does your spouse have unused allowance? Consider moving assets to them.

Suppose you have used up your capital gains tax allowance for the financial year (£12,300). However, your spouse has not. Here, you could consider transferring them to save on tax.

The government allows you and your spouse (or civil partner) to move assets between you, tax-free, if you were living together in the financial year that you made the transfer.

You are not required to be living with the other person at the time of the transfer.

This could, theoretically, let a married couple or civil partners double their CGT allowance within a given financial year - i.e. to £24,600.

Bear in mind that couples who are not married or civil partners cannot do this, even if you have been cohabiting for a long time and have had children together.

Business tax planning

Structure your self-employed or company taxes efficiently.

If you are self-employed or a director of your own company, you need to consider managing your business affairs tax efficiently.

Self-employed people will need to fill out a Self Assessment tax return each year. They will also need to keep an accurate record of their business expenditure to ensure they can off-set the right expenses against their tax return and not overpay on their profits.

Limited company directors can also benefit from a range of tax mitigation options. One idea is to establish a dividend program, which can reduce your National Insurance Contributions (NICs). You could also consider making company funded pension contributions.

Another idea is to set up tax-deductible employee benefits such as Relevant Life assurance. Not only does this offer your family a lump sum if you die, it could be a more cost-effective way to get comprehensive life insurance cover.

Pensions

Pension planning & tax

Give more money back to your future self using pension tax reliefs.

One of the best ways to save on an immediate tax bill - and improve your future retirement income - is through pension contributions. This is particularly true for higher earners.

Suppose you earn £70,000 per year, placing £19,730 of your earnings into the Higher Rate income tax bracket (40%) and leading to a bill of £7,892. Assuming you can afford it, instead you could put the £19,730 straight into your pension.

Due to tax relief rules, this effectively takes the £7,892 you would have paid in income tax and invests it in your retirement.

Another benefit of pension pots is that they are exempt from inheritance tax. So, not only could a pension be a tax-efficient way to provide you with a future income, it could also be a great way to bequeath a strong legacy (any remaining funds after your death) to your loved ones.

Bear in mind that, if you die after the age of 75, any pension funds your beneficiaries inherit will be subject to income tax. Without planning, this could push them into a higher bracket.

TAX

Tax-efficient investments

Using attractive government investment schemes.

For investors with more capital and an appetite for higher risk and reward, there are some great options to consider. Venture Capital Trusts (VCTs), for instance, are investment companies listed on the London Stock Exchange (LSE) that offer some nice tax benefits.

In particular, when you buy shares in a new VCT share offer, you can claim 30% Income Tax credit on investments of up to £200,000 (each financial year). When you eventually sell the VCT shares you do not need to pay capital gains tax.

Another option is to consider investing in companies which qualify for the Enterprise Investment Scheme (EIS). This lets you claim EIS Income tax relief at 30% of the amount invested. Again, any capital gains are tax-free (provided shares are held for at least three years).

The Seed Enterprise Investment Scheme (SEIS) works very similarly, but focuses more on startups and grants 50% initial Income Tax relief. You are also limited to investing up to £150,000 per financial year.

Please note this is not intended as individual advice as circumstances will vary. You should always seek professional advice. The value of your investment can go down as well as up, and you can get back less than you originally invested.

Related resource

Inheritance tax: what it is, and how to mitigate it

A guide to help you understand the rules around inheritance tax

Inheritance tax planning

Setting your affairs in order to leave the most meaningful legacy.

For anyone looking to leave wealth to loved ones after their death, mitigating inheritance tax (IHT) will be a key concern. In 2021-22, IHT is levied at £325,000 on the value of your estate. The typical rate is 40%.

There are a range of strategies open to people looking to legitimately reduce a future bill. One is to make use of your Main Residence Nil Rate Band, which lets you pass on an extra £175,000 to your direct descendants if this includes your main home.

Another option is to use your annual exemption to gift up to £3,000 per financial year, which is then excluded from the value of your estate. You can also make as many small £250 IHT-free gifts as you like to different individuals.

Some final ideas include making wedding gifts to your children and/or grandchildren (also free from IHT up to £5,000 and £2,500, respectively), and making use of the “7 year rule”. The latter lets you exclude a large gift from the value of your estate provided you survive it by 7 years.

The value of professional insight and guidance

How a financial planner can help

Tax planning, as this guide shows, involves many different areas of finance and wealth. These can all impact each other, requiring quite intricate knowledge about how these dynamics work.

This is where a financial planner can add immense value. As a professional who is well-versed in the different taxes involved and how they interrelate, this person can help you make the most well-informed decisions about how to optimise your tax position.

A financial planner can also draw attention to aspects of your plan which need updating as new tax rules come into force, and as your wealth grows and changes.

As your assets increase in value and variety across your life, this adds new complexity as well as opportunity. It can provide great peace of mind to have the help of an experienced financial planner guiding you through this process.

Tax Planning

The complete guide to tax mitigation

Keep more wealth within the family with tax-efficient planning

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