Tax-Saving Strategies for the Additional Rate
Please note that this content is for inspiration and information purposes only. It should not be taken as financial advice. Tax laws and pension rules are subject to change, and this content is accurate at the time of writing. To receive regulated, tailored financial advice regarding your own affairs and goals, please consult a financial advisor here in Meriden or in your area.
Taxes become more complicated in the UK when you earn more money and when your income streams are more diverse. For those in the Additional Rate tax bracket this certainly tends to hold true for their experience. In 2021-22, the income tax rate for income over £150,000 stands at 45% at the time of writing (except in Scotland where it’s 46%).
Many of our clients here in Coventry and the wider Midlands understandably baulk at this near-50% tax on their income, and mirror others across the country in wanting to understand if there are legitimate ways to minimise unnecessarily paying the Additional Rate.
#1 Pension contributions
If you are not spending all of your hard-earned £150,000+ annual salary, then it can be a good idea to consider putting some of it into your pension. In 2021-22, you can put up to £40,000 into your pension funds (for those with overall income of over £200,000 this figure can be tapered by up to £36,000 however). These contributions will receive tax relief of up to 45% for Additional Rate Taxpayers (20% being received from the UK Government at source, up to 25% via your Tax Return). You may also have unused annual allowances from up to the 3 previous tax years which may also be available to utilise. Not only is this a great way to reduce your exposure to the Additional Rate in the short term; it helps secure your retirement lifestyle in the future.
Be careful to consult a professional financial advisor, however, as there are many common traps which are easy to fall into, which can result in liability to tax charges. The Lifetime Allowance, for instance, in 2021-22 allows you to save up to a total of £1,073,100 into your pension pot(s). If you are not careful, simply putting tens of thousands into your pension funds over many years could see you unintentionally break this Lifetime Allowance threshold.
#2 Use your ISAs
Not all additional rate taxpayers are aware that in 2021-22 you can put up to £20,000 into Individual Savings Accounts (ISAs) and shield the interest, gains and dividends which they earn from the taxman. Over time, this can amount to a lot of money saved. Ten years of £20,000 ISA savings, for instance, represents £200,000 which could help provide a supplementary, tax-free income (e.g. via dividends and withdrawals from interest earned).
#3 Tax-efficient investment schemes
For those with an appetite and tolerance for high investment risk (which carries the potential for higher returns/losses), there are many investment schemes available which you can discuss with your financial advisor to potentially reduce your Additional Rate tax liability.
Venture Capital Trusts (VCTs) are investment companies listed on the London Stock Exchange and invest in smaller companies that meet specific qualifying criteria. You can invest up to £200,000 per tax year, and these offer not only tax-free growth and dividends, but also 30% Income Tax relief (providing you remain invested in the VCT for a minimum of 5 years). Therefore, if you invest £50,000 into a VCT, your Income Tax bill will be reduced by £15,000.
Enterprise Investment Schemes (EIS), are designed to promote investment into exciting unlisted UK startup companies which are pioneering new technologies, products and services by offering a series of attractive tax benefits for investors.
You can invest up to £1 Million (or £2 Million if at least £1 Million is invested in knowledge intensive companies), and similar to VCTs, they offer tax-free growth and offer 30% Income Tax relief (providing you remain invested in the EIS for a minimum of 3 years).
However, due to the greater investment risk and lesser liquidity than a VCT, the potential tax benefits are wider ranging:
- Capital Gains Tax (CGT) Deferral – If you have realised a chargeable gain (e.g. by selling investments or a second home) and invest that gain in an EIS-qualifying investment, you can defer the capital gain for as long as the money stays invested and the EIS conditions are not breached. You can defer gains made in the 3 years before or 1 year after an EIS investment, even if you have already paid the CGT.
- Providing the EIS is held for 2 years, the value of the EIS is outside of your taxable estate for Inheritance Tax.
- Income Tax relief can be carried back and offset against your Income Tax bill in the previous tax year as well as the current tax year.
- Should an EIS fail, they offer Loss Relief at your highest rate of tax which can be offset against your income (NB the sum on which this relief is calculated is based on the EIS investment sum less Income Tax relief already received)
#4 Spousal benefits
If you are married or in a civil partnership, then there might be other tax-saving strategies open to you which you can discuss with your financial advisor. If you are an Additional or Higher Rate taxpayer and your partner is not, for instance, then it might be worth transferring certain assets, savings and investments to them.
In 2021-22, for instance, the capital gains allowance is £12,300. If your spouse or partner has not fully leveraged this allowance for the tax year and you have, then it might be a good idea to transfer some of your assets so these gains come under their name. Effectively, this means that a legally-partnered couple in 2021-22 could generate up to £24,600 per tax year, without facing CGT. A similar strategy can also be used in other areas of taxation. For example, if you have used up your £20,000 ISA allowance for the tax year and yet your partner or spouse has not, then you could think about putting some of your savings or investments into their ISA(s) to reduce their exposure to unnecessary tax.
If you would like to speak to us about your tax-saving strategy, please get in touch to arrange a free consultation with our team here at BRI.
Telephone: 01676 523550
Risk Warnings specific to VCTs and EISs:
VCTs are often small, unlisted companies in the earlier stage of their development and carry a greater risk of failing when compared against larger, fully listed companies.
Shares in unquoted companies or companies admitted to trading on AIM may be higher risk than companies listed on the London Stock Exchange Official List. Investments in shares in unquoted companies are not readily marketable and the timing of any realisation cannot be predicted.
EISs are high-risk investments and may only be suitable as medium or long-term investments. EISs are complex products and may only be suitable for wealthier investors as part of a diversified investment portfolio.
EIS shares are issued by small companies, which are typically early stage, young companies. There is a risk that these companies may not perform as hoped and in some circumstances they may fail completely. Small companies have a higher failure rate than large established companies.
Investments in these small companies will generally not be publicly traded or freely marketable and you may have difficulty selling your investment at a reasonable price and, in some circumstances, it may be difficult to sell it at any price. There is a restricted market for EIS shares, and it may therefore be difficult to deal in EIS shares, or to obtain reliable information about their value or how risky they are. Proper information for working out the current value of investments may not be available.
The levels of charges for EISs may be greater than for other investments, such as Unit Trusts and Open Ended Investment Companies. EIS investments may be subject to sudden and large falls in value, you could get back nothing at all.
Tax relief and the beneficial tax treatment of certain investments may not continue in the future.