20 ways to pay less tax: cut your Income Tax, Council Tax, and Inheritance Tax
Reduce your tax bill without breaking the law, by saving money on Income Tax, Council Tax, pension accumulation and withdrawal, using ISA and savings allowances, Stamp Duty exemptions and more.
How much tax you pay in your life
The amount of tax each person pays during their adult life will obviously vary massively from one to the next.
However, it is possible to take a stab at how much Mr and Ms Average will hand back to the taxman both during their time on this earth/
Right of centre Think tank The Taxpayer Alliance crunched all the numbers back in 2016 and determined an average household will pay £826,030 in direct and indirect taxes.
- £287,963 in Income Tax
- £169,371 in VAT
- £107,045 in Employee's National Insurance Contributions
- £65,068 in Council Tax
Here, we provide tax-cutting tips that you needn't feel guilty about – in fact, you should feel bad if you don't make use of them!
Check your tax code
Your tax code is a series of letters and numbers that determine what your Personal Allowance is. This is how much you can earn before Income Tax kicks in.
For most people in 2020-221, their tax code will be 1250L if they have one job or pension.
This code indicates that the taxpayer is under 65, earns less than 100,000 and so is entitled to £12,500 Personal Allowance before they begin paying Income Tax on their earnings.
You should double-check your tax code each year to make sure you aren’t on the wrong one, as you may then be paying too much to HM Revenue & Customs.
If you find that more tax has been collected than you needed to pay, claim your money back! To do this, you will need to contact HMRC in writing.
You should enclose relevant copies of forms like P60s and P45s, as well as an explanation of why you believe you are owed a refund.
Use your Personal Savings Allowance
You can earn up to £1,000 in interest from savings without paying any tax.
The Personal Savings Allowance (PSA) is applied automatically and is £1,000 for Basic Rate taxpayers and £500 for Higher Rate taxpayers (Additional Rate earners get nothing).
Current accounts, fixed-rate bonds and regular savers, credit unions, peer-to-peer platforms, corporate bonds and Government bonds are covered by the PSA.
Given the low level of interest rates at the moment, you'd need upwards of £40,000 in a best buy savings account to even get close to exceeding the PSA for basic-rate taxpayers.
Once you've crossed the £1,000 / £500 threshold, you should put your other savings in an ISA.
Open an ISA
The Personal Savings Allowance doesn’t mean you should ditch your existing ISA or not bother opening one at all. That’s because ISAs shield your savings from taxes over the long term.
The 2020/21 ISA allowance for adults is £20,000, which can be saved in a Cash ISA, Stocks and Shares ISA, Innovative Finance ISA or Lifetime ISA.
Children under the age of 18 also get a very generous tax-free savings allowance through a Junior ISA. In 2020/21, up to £9,000 can be put away in a Junior ISA (Cash and/or Stocks and Shares).
Invest in Premium Bonds
If you’ve used up your ISA allowance for the tax year but still have some money to put away, you could try National Savings & Investment Premium Bonds.
Premium Bonds allow you to save from £25 up to £50,000 and offers easy access to your cash.
But they aren’t like normal savings accounts as they don’t pay a regular return on your money.
Instead, the interest that should be paid is used to fund a monthly prize draw, where bondholders can win between £25 and £1 million – or nothing at all.
Prizes are tax-free. And what's more, deposits are 100% backed by the Treasury.
Pay into a pension scheme
But that doesn't mean you should be satisfied with making the lowest contributions.
When you pay into a pension scheme, you benefit from tax relief on your contributions based on the highest rate of Income Tax you pay.
The way you get the tax relief depends on the type of scheme you belong to.
In a workplace pension, your employer will deduct your contribution before you pay tax.
Don’t blow pension savings
Pension freedom laws introduced in 2015 allow anyone aged 55 or over to take all of the cash from their pension savings for the first time. You can then do whatever you want with it.
But beware! Withdrawing your whole pot could land you with a massive tax bill.
Pension rules say you can take 25% of your pension pot as cash in one lump sum, or multiple withdrawals, tax-free.
Stop paying National Insurance Contributions
Older people that carry on working beyond the State Pension age don’t have to make National Insurance Class 1 and Class 2 contributions.
Make sure you stop these being taken from your wages by showing proof of age to your employer or writing to HMRC to get a letter confirming you have reached State Pension age.
Be proactive with Inheritance Tax planning
When you die, Inheritance Tax is charged at 40% on the value of your estate that exceeds £325,000 (£650,000 for people who are married, in a civil partnership or widowed).
So, if you think your estate will liable for tax, you should start making plans now to protect your wealth from the taxman and give more to the people you love.
One way is to make gifts of your money before you die (up to £3,000 per year). Leaving 10% or more of your estate to charity can also reduce your tax bill to 36%.
Extra tax relief
If you plan to pass your property on to children or grandchildren, then you should also be aware of the nil-rate band, which is worth an extra £175,000.
This band sits on top of the existing Inheritance Tax threshold, so will create an effective threshold of £500,000 for individuals and £1 million for couples in the 2020/21 tax year.
Know your Capital Gains Tax rights
Capital Gains Tax (CGT) is payable on the profits made from selling assets like property (not your main home) and investments.
You don’t have to pay if your gains are under your tax-free allowance. In 2020/21, the capital gains you can get tax-free is £12,300.
After the tax-free allowance, CGT is charged according to your tax band.
The rate of CGT for basic rate (20%) taxpayers is 10% (or 18% on residential property) and the rate for higher rate taxpayers (40% or 45%) is 20% (or 28% for residential property). However, as we pointed out in our guide to minimising CGT, this tax could soon be hiked in order to boost the Government's pandemic-hit finances.
There are lots of savvy ways to save on CGT, including using an ISA, investing in certain small businesses, making extra pension contributions, offsetting losses against gains and spreading gains over tax years.
Take advantage of the Dividend Allowance
Investors receiving dividend income can still benefit from a reduced dividend allowance.
Only the first £2,000 of dividends you receive from your investments will be tax-free (this allowance is unchanged for the 2020/21 tax year).
After this tax-free allowance, you will have to pay tax at 7.5% if you are a basic rate taxpayer, 32.5% if you are a higher rate taxpayer or 38.1% if you are an additional rate taxpayer.
Sharing economy tax relief
The Government has finally caught up with the proliferation of eBay, Gumtree and similar sites, with the launch of two tax relief schemes for the 'sharing economy'.
The first £1,000 you make from selling your old stuff online, or items you've made, is now tax-free – beyond that, you'll have to pay income tax.
Additionally, the first £1,000 you make from your property, for things like renting out your driveway, is tax-free.
That's on top of the Rent a Room scheme if you're eligible.
Use Stamp Duty holidays and exemptions
One of the big handouts in the Chancellor's Summer Statement was a nine-month holiday on the much hated property tax,
Called Stamp Duty Land Tax (SDLT), anyone who buy a home for under £500,000 (including second homebuyers and landlods) will pay no tax.
After the deadline, it'll revert to the nuormal tiers, which are charged at different rates depending on the portion of the purchase price that falls into a band.
Higher rates apply if your purchase is a second home or buy-to-let investment.
Read Stamp Duty explained for more information.
First0time buyers will pay 0% on the first £300,000 of the property’s value, then a reduced rate on the remainder up to £500,000.
However, if the property price is above £500,000, you'll have to pay the normal rate for the whole amount.
One way to pay no Stamp Duty is to find a property for residential buyers to buy for less than £125,000.
Take a look at How to beat Stamp Duty for more ideas.
Challenge your Council Tax band
You could be paying more than you need to on your Council Tax bill.
The amount households pay in England and Scotland is based on old property valuations from the 1990s, so they could be completely out of date.
With Council Tax rising by an average of 5% in England, it’s a good time to try and get your band changed.
Take in a lodger
The Rent a Room scheme allows homeowners to take in a lodger and enjoy tax relief on rental income.
It means you don’t have to pay a penny in tax on the first £7,500 you make in rent each year (or half if you share the income with someone else).
Resident landlords and those that run a bed and breakfast or guest house are eligible to opt into the scheme to benefit from this relief.
Married couples and civil partners born after 6 April 1935 may be able to take advantage of a tax break called the Marriage Allowance.
It allows a partner who generally earns less than £12,500 a year to transfer up to £1,250 of their Personal Allowance to their higher-earning spouse.
The Government estimates the scheme could reduce the amount of tax by up to £250 every tax year.
If you and your partner were born before 6 April 1935, you may be entitled to Married Couple’s Allowance instead of Marriage Allowance.
Trust your partner
You can transfer savings and investments to your husband, wife or civil partner if they pay a lower rate of tax than you do, as they may pay more favourable Income Tax rates.
It has to be a genuine gift, so you can’t ask for it back if you break up or change your mind.
Give to charity
The Government pays tax relief on charity donations.
Both you and the charity can benefit, but it depends on how you donate.
Donating through Gift Aid means charities and community amateur sports clubs (CASCs) can claim 25p for every £1 you give back from the Government.
Higher rate taxpayers can claim the difference between their rate and the basic rate on the donation on their self-assessment tax return.
Those that donate through a Payroll Giving scheme will donate from their gross wage or pension, so you'll then pay less tax on your remaining income.
And don't forget that those that donate at least 10% of their estate in their will get a reduced Inheritance Tax rate. Read How to cut your Inheritance Tax bill for more information.
Stick to deadlines
If you have to file a self-assessment tax return, make sure you don’t miss the deadlines as you’ll be hit with an instant £100 fine, and more charges will be levied the longer you leave it.
Read What to do if you haven't filed your tax return yet on how to limit the damage.
The deadline for paper returns is 31 October, while the online deadline is 31 January.
Take a look at How to get your online self-assessment tax return right for help getting it done on time.
Self-employed people and private landlords are allowed to deduct some business expenses before paying tax on their income.
Allowable expenses for the self-employed include travel costs, the running costs of the business premises (including a home office) and buying stationery.
Meanwhile, private landlords can claim for things like agent fees, maintenance, repairs, services like a gardener, legal fees and direct costs such as phone calls, stationery and advertising for new tenants.
They can also offset 25% of the tax on their mortgage interest and for wear and tear on their property, but the Government is reducing this tax break and will end it completely in 2020.
Landlords and those that run a business can also take advantage of the Annual Investment Allowance (AIA) to claim tax back for capital expenditure on specific items.
The limit has temporarily risen to £1 million until 31 December 2020, up from £200,000.
Claim the benefits you're entitled to
This one isn't strictly tax-related, but if you're paying your taxes, you may as well get something back.
Some of these include tax reductions – older people with limited savings, for example, could get money off Council Tax.
Not claiming these benefits could be effectively costing households thousands of pounds, as our writer found.
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