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By 2026, over 1m people are expected to pay a higher rate of tax. This is due to frozen tax bands and rising average UK wages. Could you be caught out? How can you prepare?
In this article, we explore different options for investors to protect their income and returns in 2023-24. We hope this content is useful to you. To find out more about our EIS pipeline and other opportunities, visit our portfolio page here. For enquiries regarding our latest projects and funding, you can reach us via:
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Why more people are expected to pay higher taxes
In 2023-24 there are three primary income tax bands: the basic rate (20%), the higher rate (45%) and the additional rate (45%). The first applies to income between £12,571 – £50,270, the second between £50,271 – £125,140 and the last anything above £125,141.
There is a tax-free personal allowance which frees an individual from tax on income below £12,570. However, this tax-free allowance goes down by £1 for every £2 that an individual earns above £100,000 – effectively eliminated at £125,140 of earnings.
These thresholds have been frozen until 2027-28. Whilst some taxpayers have been relieved that the government has not raised income taxes, others have criticised the freeze as a “stealth tax” which could catch many people off-guard.
In Q1 of 2023, for instance, UK average wage growth was 5.8%. If wages continue to grow (to try and keep up with inflation), then certain taxpayers will end up crossing the threshold into a higher tax bracket – perhaps without even realising.
For instance, suppose you earn £100,000 in 2023 and your wage grows by 10% each year. In three years’ time (2026), assuming this wage growth continues, the income would cross the additional rate threshold (£125,140).
What are your options for avoiding the tax trap?
Before the 2023-24 tax year (starting in April), UK taxpayers were already facing their highest tax burden in 70 years. Now, with some new tax changes (e.g. the reduced tax-free allowance for capital gains), the burden is even heavier. Fortunately, you still have some options.
Firstly, if you have a lower-earning spouse or civil partner, then consider transferring some of your income-producing assets to him/her to take advantage of their tax-free allowances.
For instance, in 2023-24 a higher rate taxpyayer can earn up to £500 each year from interest (e.g. cash savings) without facing tax. A basic rate taxpayer can earn up to £1,000. So, if you are nearing your tax-free threshold, you might consider transferring some of the cash to your spouse so that your household can keep more of the interest.
You can also transfer assets which produce a capital gain to your spouse/civil partner without facing a tax liability. This opens up options for structuring your household’s assets in a more tax-efficient manner.
For example, in 2023-24 you can earn up to £6,000 in tax-free capital gains (outside of an ISA). So, suppose your spouse has not used their own allowance for 2023-24. You want to sell assets which would produce £10,000 in capital gains. By transferring to your spouse assets which produce £4,000 of the gains, you can avoid incurring an immediate CGT liability.
Another idea is to look at your pension contributions. For instance, if you earn £105,000 in a single tax year, then your tax-free personal allowance will be eroded by £2,500. However, if you put this £5,000 into your pension, you get 40% tax relief on the contribution and you reinstate your full personal allowance.
Giving to charity can also be a viable tax planning option for some investors. When you make a donation using Gift Aid, your basic and higher rate tax bands are extended by the gross charitable donation. This “expands” the amount of income that can be taxed at a lower rate.
For instance, suppose a higher rate taxpayer gives £100 to a registered UK charity and claims Gift Aid on the donation. This will “extend” this person’s basic rate band by £125. This means that £125 that would have been taxed at 40% will, instead, now by taxed at 20%.
A final idea to consider is for company directors. Here, you might receive a salary from your company as well as a dividend. The two fall under separate taxes – income tax for the former and dividend tax for the latter.
With some careful planning, certain directors may be able to mitigate their overall tax bill on the two. Dividend tax rates are lower than income tax rates. So it can make sense, in some cases, for a director to take a lower salary and increase their dividend to reduce taxes.
However, be careful to consult professional advice before making big decisions about your salary and dividend. There can be knock-on effects to other parts of your financial plan. For example, taking a lower salary may restrict how much you can borrow for a mortgage.
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