Personal tax planning tips for year-end

1. Maximise free government money

Whether it’s your pension, your Lifetime ISA or ensuring you claim tax breaks that you are eligible for, it’s important to get as much free government cash as you are entitled to.

Pensions benefit from tax relief at 20% for basic rate taxpayers, but higher and additional rate payers can reclaim an additional 20% or 25% tax relief respectively through their tax return. That means for a basic rate taxpayer every £1 in your pension only costs you 80p and for a higher rate taxpayer every £1 in your pension only costs you 60p.

Anyone using a Lifetime ISA can also get up to £1,000 of free money from the government each year, if you put in the maximum £4,000 contribution, bearing in mind that the age limit to open a Lifetime ISA is 39 years.

Just be aware that you can withdraw Lifetime ISA money once you’ve reached age 60 or earlier to buy your first property, but if you take the money out for any other reason (apart from severe ill health) there is an exit penalty of 25%.

It is also worth checking that you are claiming any government tax-breaks that you are eligible for, such as the marriage allowance or tax-free childcare, which gives a 20% top-up to money you use for childcare.

2. Use your ISA and pension annual allowances

ISAs and pensions are a great way to save for the future because any income and capital gains made on investments held in both are free from income tax and capital gains tax.

Everyone over the age of 16 can save £20,000 each year in a cash ISA and anyone over the age of 18 can save the same amount in a Stocks and Shares ISA. Those aged 18 to 39 can open a Lifetime ISA and save up to £4,000 each year.

The crucial thing with ISAs is if you do not use all the allowance it cannot be carried forward to future tax years, so you lose it for good. Investors with spare money they plan to save and any unused ISA allowance for this year should consider using it before the 5 April deadline.

The pension annual allowance for this tax year is £40,000 or 100% of earnings if that is lower - this includes both contributions made by you and your employer. The annual allowance can be carried forward for up to three years, so investors should consider whether they have made as much use of their pension annual allowance as possible ahead of the end of the tax year. Note that anyone with a very high income or who has already started to take taxable income from their pension will have a restricted annual pension limit.

If you want to carry forward any previously unused pension allowance, you will only get tax relief on personal contributions up to 100% of your earnings for that year. People with no earnings (including children) can still save up to £3,600 a year in a pension (including basic rate tax relief).

3. Shelter more of your investments from tax

If you’ve got investments outside of your ISA you can use something called ‘Bed and Isa’ to funnel them into an ISA and protect them from tax. You need to check you have got some of your £20,000 ISA allowance left, and then use your investment platform’s Bed and ISA service, which means the investment outside of the ISA is sold, the proceeds moved into an ISA and used immediately to purchase the same investment within the ISA.

You just need to be aware that if you’ve made any gains on the investment outside an ISA you may have to pay tax on them when you sell them as part of this process. For this reason, lots of people sell enough of the investment to take them up to their capital gains tax free allowance of £12,300.

4. Use your capital gains allowance to cut your future tax bill

Any investments held outside an ISA or pension will be subject to capital gains tax (CGT), which means the annual tax-free allowance is very valuable. Investors can make investment gains of up to £12,300 in 2021-22 without paying any tax.

Gains over that amount are added to income and if they fall in the basic rate tax band are taxed at 10% and at 20% for the higher rate tax band. An additional 8% is added to the tax rate if the gains are from a second property.

The annual capital gains tax-free allowance cannot be carried forward into future years so if you do not use it, you lose it. If you have investments with gains outside of an ISA or pension you should consider whether to realise some of that gain before the end the tax year to make the most of your tax-free allowance.

If you’re in a couple you can get double this allowance as you can transfer investments to your spouse to use their annual CGT allowance too. This means that for the current tax year you can lock-in up to £24,600 of gains before you face any tax.

5. Beat the dividend tax rise with your ISA

People with lots of income-producing investments outside an ISA or pension will face a higher tax rate this year, if they earn more than £2,000 in dividends in a tax year. That is because the dividend tax is rising, with an extra 1.25% being added to all the tax rates, regardless of the level of dividend tax you pay.

That means any dividend income above this amount is taxed at 8.75% for a basic rate taxpayer, 33.75% for a higher rate taxpayer or 39.35% for additional rate taxpayers. Someone with £10,000 of dividends outside an ISA will pay an extra £100 a year in tax as a result.

This means that it is more beneficial than ever to put your income-producing investments inside an ISA, to protect them from tax. You can use the bed and ISA process to move assets into an ISA, but if you have too many investments to move them all in one tax year you should prioritise the ones paying the highest amount of dividends.

6. Set up regular investing – to take the hassle out of saving

Lots of people have a to-do list as long as their arm, meaning there is inevitably stuff you don’t get around to doing. But if you set up regular investing that ticks something off and takes the hassle out of saving money each month.

You can easily set up a direct debit that will automatically transfer the money into your investment account each month (maybe on payday) and then set up regular investing on your platform, which will automatically buy the funds or shares you’ve chosen.

Many investment platforms will allow you to start from as little as £25 or £50 a month. You can always pause it one month if you need to skip a month, but it means you don’t have to actively log-in and invest money every month. What’s more it can help to smooth out any short-term volatility. If stock prices fall, you are investing at that lower price and could benefit even more over the long term if prices rise.

7. Set up automatic dividend reinvestment

Any dividends from investments in your ISA can be withdrawn tax-free, but if you don’t need the income now you could use them to turbo-charge your returns. If you reinvest them, you can buy more shares in the same investment, which can have a dramatic impact on the size of your ISA fund over the long term.

This is because when you buy more shares each time you receive a dividend, you then receive more dividends next time there is a payout, which can then be reinvested again and so on. Some investment platforms allow you to set this up to happen automatically.

Let’s assume someone invests the full ISA allowance of £20,000 and we assume a compound annual growth rate of 5% and annual dividend yield of 4% a year. The initial £20,000 will be worth £53,066 after 20 years, and on top of that £26,453 would also have been banked in cash dividends, to give a total return of £79,519.

However, an investor who reinvests the dividends rather than banking them would have £112,088 – more than £32,500 extra. The figures become even more attractive over longer periods:

8. Tackle the inflation bogeyman

Inflation is most savers’ biggest worry at the moment, with the Bank of England expecting it to peak in April at 7.25%. And it’s not just a flash in the pan, the Bank is predicting it will still be above 5% in a year’s time.

Alongside that, interest rates are still very low, despite two increases in the base rate from the Bank. That means any money held in cash is not keeping pace with inflation, so its spending power is being eaten away. Around two-thirds of new subscriptions to ISAs are in cash, showing lots of people choose to stick to cash rather than invest it.

While cash is a great place for short-term savings or money you need quick access to, it’s not ideal for long-term savings. So, work out what you need in the next five years or as an emergency pot, and see how that stacks up against the amount you’ve got in cash. If you’ve got more than that set aside, think about investing it to generate a potentially higher return.

If you saved £200 a month into a cash ISA, earning the current average ISA interest rate of 0.19% you’d have a pot worth £24,250 after 10 years. But if you invested that and earned 5% interest a year, you’d have almost £31,700 – £7,444 more.

9. Avoid getting caught in a tax trap

The tax-free personal allowance for most people is currently £12,570. When your taxable income reaches £100,000, your personal allowance is cut by £1 for every £2 of your income, which means you lose it completely once your income reaches £125,140.

For example, someone who gets a pay rise from £100,000 to £110,000 will lose £5,000 of their personal allowance. They will be taxed at the normal 40% income tax on their pay rise, amounting to £4,000, and then taxed at 40% on their lost personal allowance, amounting to £2,000. This means they pay £6,000 on the £10,000 pay rise – an effective tax rate of 60%.

If you are in this position, you could consider reducing your taxable income so that it falls below the £100,000 level where the personal allowance starts to be eroded. There are two ways you can do this: by making charity donations or contributing to a pension.

By contributing to a pension, you are a making tax savings in the form of getting your personal allowance back whilst also saving for your future and benefiting from pension tax relief at 40%, so you wipe out the 60% effective tax rate completely.

10. Don’t miss out on child benefit

In a similar way as above, people will start to lose their child benefit when one half of the couple earns more than £50,000 – and the benefit will be wiped out entirely when they hit £60,000. The frustrating factor for many parents is that the rule applies if one parent is earning more than £50,000, regardless of their partner’s income. So, you could have both parents earning £48,000 each and have no problem, but if one earns nothing and the other earns £60,000 you’ll lose the benefit.

A parent with two children will get £1,828 a year in child benefit, but for every £1,000 they earn over £50,000 they will lose 10% of their child benefit – so someone earning £51,000 will lose £183.

However, parents who have just tipped over the threshold can get around this by increasing their pension contributions. What’s counted for the purposes of the child benefit high income charge is your salary after any pension deductions. This means if you contribute enough to your pension to get your salary back to £49,999 then you’ll get the full child benefit again.

Another option is to make charitable donations from any income over the £50,000 limit, which you’ll need to declare to HMRC on your tax return.

11. Tackle your missing pensions

The government estimates that people switch jobs 11 times during their life, which means most people will have lots of pension pots they’ve lost track of.

If you know you’ve got a pension but cannot remember where it is, your first port of call is finding any old paperwork for it. It should tell you where your pension is, how to log on to see its value, and whether you can transfer it. If you cannot find any documents, you can use the government’s pension tracking service instead.

Tracking down these old pots makes sense for a number of reasons. Firstly, knowing how much you have saved in total will help you work out how much you might need to put away in the future to enjoy the retirement you want.

Secondly, once you’ve located any old defined contribution pensions, you could consider combining them with your existing provider. This will make your pensions easier to monitor and manage. And you could also benefit from lower charges, greater investment choice and more flexibility when you come to access your pot. Before you transfer any old pensions, just make sure you double check whether they have any guarantees attached, as you could lose them if you switch to a new provider.

12. Start saving for your children

Like adults, children also have tax allowances that can be used each year. The Junior ISA allowance is now a very generous £9,000 a year, which means that if you have spare cash you can start building a very healthy fund for your children’s future. They won’t be able to access the money until they are 18, at which point it automatically turns into a normal ISA and transfers into their name, giving them full access.

If you contribute the maximum £9,000 each year and achieved a 5% investment return after charges each year, the pot would be worth almost £266,000 by the time your child turns 18. If they don’t touch the fund and don’t pay any more into it, the pot would hit £1m by the time they turn 46.

For many families putting the full £9,000 into the pot isn’t realistic, particularly if you have more than one child. But even a more modest £50 a month, earning 5% returns a year, would give your child a £16,000 present on their 18th birthday.

You can also pay up to £2,880 into a Junior SIPP each year, with government tax relief automatically boosting that to £3,600. Your child will not be able to access the money until they are at least age 57, maybe later if the government increases the age limit, which means there’s plenty of time for them to benefit from compound investment returns.

If you paid in the maximum each year until your child turns 18 and they don’t contribute anything else, assuming 5% investment returns each year after charges, the pot would be worth £713,000 by the time they turn 57 or just over £1.1m by the time they hit the current state pension age of 66.