Which tax categories do you fall into?
If you’re a saver: With the interest rates where they are, you can’t afford to miss a penny of savings at the moment. That means being tax efficient and making use of the maximum allowances, and these often go hand in hand. This comes down to making use of the personal savings allowance (£1,000) per year for a basic-rate taxpayer, at the time of writing, and the ISA allowance (£20,000). Any savings that accrue interest, like Government gilts, bonds, unit trust or similar funds will count towards your limit. Low income earners (£12,500 and under) can benefit from a ’starting rate’ of income tax of 0% for up to £5,000 of savings interest.
If you’re an employee: One of the big benefits of employment is that many of the fine details regarding the tax year are taken care of via your tax code. If you are employed you won’t need to file a self-assessment form for additional savings or investments.. However, other income streams, like share dividends, rental income or even charging people to park on your property, will mean you’ll most likely have to do a self assessment. A workplace pension or savings scheme can attract tax relief such as ‘relief at source’ or ‘net pay’ arrangements. You’ll need to check with your employers how it works in each case.
If you’re an investor: When it comes to investments, looking at all the rules is much more time intensive than it is for savings. Tax efficiency is an important part of investing, and so a good understanding of the tax rules here is essential. Since the range of possible investment types is very diverse, you’ll have to account for pension rules, dividend tax rates and rules around the buying and selling of assets like shares and property. We can’t cover all of that in this guide (so we’ve written a separate guide: Complete Guide to Investment Planning), but you’ll need to be clear how each of your investments will be taxed so your overall strategy makes the best use of allowances.
If you’re self-employed: Depending on the structure of your business, sole-trader, partnership (or limited liability partnership (LLP), or limited company (LTD), you’ll need to arrange your tax affairs differently. As a sole trader or partnership / LLP, you’ll be taxed under income tax rules based on your business’s profits. This keeps things fairly simple. You notify Her Majesty’s Revenue and Customs (HMRC) using the self assessment system. It’s your responsibility to alert HMRC that you’re now self-employed. These types of businesses don’t allow the owner to be paid as PAYE, even if you operate a PAYE scheme for employees.
If you run a limited company: Things get more complex. A company director can remunerate themselves via a combination of dividends and declaring themselves an employee of the company and using PAYE. Your personal circumstances will dictate what is the most tax efficient way to pay yourself as a company director. Both dividends and salary have a personal allowance, but are taken off your overall total income and taxed at different rates.
For example: If you earned £3,000 in dividends and £29,500 in wages, your total income would be £32,500. If your personal allowance is £12,500, you’re left with a taxable income of £20,000 (£32,500 minus £12,500). In the basic rate tax band, you’d pay:
- 20% tax on £17,000 of wages
- No tax on £2,000 of dividends, thanks to the allowance
- 7.5% tax on £1,000 of dividends
The above is based on the tax bands at the time of writing.
Should you sell any shares in your limited company, you may have to pay capital gains tax. As a company director, it’s worth spending the time to look at the company’s goals and aims alongside your own personal financial aims. Aligning the two can offer advantages in tax and wealth planning.
PRO TIP : Making the most of self employment.
On face value tax rules seem simple when you are self-employed, but if you dig a little deeper there are some perks to being self employed. HMRC offer tax relief on a variety of allowable work-related expenditure which minimises your tax bill. Over two-thirds of self-employed people don’t have a pension and they are missing out on tax relief. For a basic rate taxpayer, every £100 you put into your pension will then be topped up with an additional £25 by the government. If you are paying the higher rate tax of 40%, then there will be an extra tax relief on top of this to claim, check this is still right. A financial adviser will help you get out of the mindset of “my business is my retirement fund”. If you make enough profit to pay tax at the higher rate of 40% then adding any donations to charity to your tax return can reduce your tax bill. The switch from a salaried role to working for yourself has challenges especially in the areas of taxation.