Five ways to reduce your tax bill

Taxes are one of the certainties of life, but it doesn’t make it feel any better when you see them come out of your income. However, if you’re smart with your money, there are ways to protect your savings and investments from unnecessary taxes, leaving more for you to enjoy down the line.

Often, the key to these savings is to act sooner rather than later. Not only does it keep you from pushing it down your to-do list until you’ve suddenly reached a new tax year again, but it can also help build up your savings along the way.

Here are five different ways you can help to reduce your tax bill, starting today.

1. Prioritise your ISA

Any money you make within an ISA wrapper, whether that's through capital gains or dividends on your investments or interest on your cash, is free from tax.

Between your different ISA accounts, you can invest £20,000 per year. But this doesn’t roll over from year to year, so you have to use it or lose it.

If you’re a Lifetime ISA holder, you’ll receive free money from the government when you contribute, as well as being able to enjoy investment rewards tax-free. You can invest up to £4,000 each year, and the government will pay a 25% bonus, giving you up to an additional £1,000 each year.

But these accounts do come with a few caveats: Lifetime ISAs must be used either for the purchase of your first home, which must be under £450,000, or kept until retirement. If you choose to withdraw your money for something else before age 60, you’ll be hit with a 25% penalty fee.

2. Take advantage of your pension

It’s important to note that pensions are not tax free upon withdrawal. But depending on what kind of pension you have, and how you contribute, you can end up with a much more tax efficient structure.

When you withdraw your pension, 25% is tax-free, and the rest is taxed as income. Already, that’s giving some relief to your income, but you can also receive relief upfront.

If you have an employer, and you choose to pay into your pension, they will have to pay in too. The base rate is a 4% salary contribution from you, and a 3% salary contribution from your employers. You will also get tax relief from the government, which will equal another 1% contribution. Self-employed people can also get tax relief when they pay into a personal pension.

Many workplaces allow you to make your pension contributions through a system called salary sacrifice. This means that your pension percentage is coming from your gross salary, instead of the amount that is left over after taxes and National Insurance.

3. Spread the wealth

If you have kids and want to start creating a nest egg for their future, you don’t need to eat into your own ISA allowance to do it. Junior ISAs have their own allowance of £9,000 per year, that comes with the same tax benefits of adult ISAs.

It’s important to realise that once money is put into a Junior ISA, it belongs to your child. They cannot withdraw the money until they are 18 or make any investment decisions with it until they are 16, but after this point it goes out of your hands. Make sure you’re comfortable with this situation before making contributions.

If you have a partner, you can also spread your allowances between the two of you. While you can’t pay into your partner’s ISA like you can with a Junior ISA, you can transfer the money to them so they can contribute that money to their ISA. That means between the two of you, there’s a cap of £40,000 in contributions. Remember, however, just like with Junior ISAs, that money is now theirs. You will not be able to have any claim on it in the future.

4. Stay ahead of inheritance tax

While you’re alive, you can give away as much money as you’d like. The recipient will not pay taxes on this money, unless you die within seven years of gifting it. While it can be the most tax-efficient method to give money away earlier in life, you also want to make sure you have enough left to live on.

Even in the case that someone passes away before the seven-year period has lapsed since a gift, there are some exemptions. There are no taxes on gifts between married couples, or if the money is being given to a charity or political party. Otherwise, you can give away £3,000 per year without tax implications. You can also give away money through regular payments without tax implications, for example if you pay your child’s rent, if this comes from your regular monthly income.

Once you’ve exceeded these amounts, inheritance tax will come on a sliding scale, dependent on the years between the gift and death.

5. Watch out for changing regulations

In recent years, capital gains tax and dividend tax allowances have both shrunk in size. While you were allowed capital gains of £12,300 on your investments outside an ISA with no tax up until April 2023, that allowance has now shrunk to £3,000. Similarly, dividend allowance has dropped from £2,000 to £500 in the past two years. Almost twice as many people will pay tax on their dividend payments versus three years ago, according to the HMRC.

Using ISAs are the easiest way to protect your gains and dividends from additional taxes. If you’ve used your ISA allowances, you can also consider what investments you have in different wrappers. Investments that are expected to make smaller gains or not pay dividends may run into fewer taxes outside a wrapper than those investments that have the potential to grow quickly or pay out larger sums.