Taxes have been taking an ever-greater chunk out of our earnings over the past few years. High earners have lost some of their personal income tax allowances, National Insurance rates have increased and Child Benefit has been withdrawn from families where one adult earns more than £60,000 a year. So what can higher earners do to diminish tax liabilities?
High earner tax planning
The top rate of income tax is now 45% for anyone earning more than £150,000 – whether that’s just salary or a mix of other income, such as rent, pension payments, or interest from savings. If Labour wins the next election, Shadow Chancellor Ed Balls insists they’ll increase the rate to 50%.
So it’s more important than ever to be tax-efficient, particularly if you are in the top tax bracket – making sure you don’t pay any more tax than necessary. There are several strategies to reduce the amount of tax that you pay:
1. Use your full ISA/NISA allowance.
Using your full Individual Savings Accounts (ISAs) allowance should be your first port of call. Get in quickly before the end of the 2013/14 year on 5 April 2014 and you can put away £11,520 in a stocks and shares ISA, minus anything you pay into a cash ISA – which is capped at £5,760. From 6 April and the beginning of the 2014-15 year, these limits rise to £11,880 and £5,940 respectively. However, from 1 July ISAs are being merged into a single account with a maximum annual allowance of £15,000. Savers can choose how much to hold in cash or invest in stocks and shares in any combination they like.
Interest from cash in ISAs and NISAs will be paid completely tax-free. Dividends income is usually taxed at 32.5% for a higher-rate taxpayer and 37.5% for an additional-rate taxpayer, however for basic-rate taxypayers dividend income is received net of 10% tax.
Once you’ve used up your own ISA/NISA allowance, you could also consider investing for your children or grandchildren by putting money into a junior ISA/NISA. Just like the adult versions, they are available as cash ISAs and stocks and shares ISAs and come with the same tax efficiencies. You can open one for each child under the age of 18 as long as they don’t already have a Child Trust Fund. £3,720 can be put away in the 2013-14 tax year, £3,840 up to 1 July 2014, and from then until the end of the 2014/15 tax year the allowance rises to £4,000. But on the child’s 18th birthday, the money becomes theirs.
2. Top up your pension
Pension contributions receive up to 45% tax relief. This means that for additional-rate taxpayers, for every £100 invested into their pension, the effective cost is £55 after tax relief. The maximum amount that can be tax efficiently saved into a pension is the lower of your annual earnings or £40,000 a year (from April 2014).
Investing in a pension, and you get the added advantage of taking a lump sum of up to 25% tax-free when you retire, or anytime from the age of 55.
3. Back small business
The government is trying to encourage more private investment in small companies. Investments in Venture Capital Trusts (VCTs), up to a limit of £200,000 a year and Enterprise Investment Schemes (EISs) up to a limit of £1 million a year benefit from 30% initial income tax relief as well as tax-free capital growth. VCTs and EISs invest in small or start-up companies that are inherently risky – and you could lose all of your money.
They have other advantages too. VCTs have the ability to distribute tax-free dividends, while EISs allow capital gains tax deferral and can also provide inheritance tax savings (100% inheritance tax relief after two years, as long as you still own the shares when you die). And with EISs, additional-rate taxpayers also get up to 45% loss relief if the companies you invest in go bust.
4. Consider your tax status as a couple
If you are a high earner but your spouse isn’t, savings and investments held in your name will incur tax at your higher rate of income tax. You could consider a simple transfer of assets between you and your spouse to make significant income tax and capital gains tax savings.
These are all legitimate tax planning methods that can be used to make sure you don’t pay a penny more to the Inland Revenue than you have to.
Any tax treatment mentioned is based on personal circumstances and current legislation which is subject to change.
Deputy editor, Moneywise magazine
The value of your investment may fall and you may get back less than you invested.
All information within this article is for illustrative purposes only and is not intended as investment advice; no investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us or your financial adviser.
The opinions expressed in this document are not the views held throughout Brewin Dolphin Ltd.
The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
Any tax allowances or thresholds mentioned are based on personal circumstances and current legislation which is subject to change