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Five essential tax-free allowances: what you need to know

Understanding your tax-free benefits could be more profitable than you think

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Topic: Investing

While the end of the tax year is fast approaching, there’s no better time to learn about your various annual tax allowances and exemptions, which are applied to your self-assessment, and could reduce your tax bill.

Here is a breakdown of five tax-free allowances which everyone in the UK should be aware of.


1. Personal tax-free allowance

The majority of people in the UK have an annual tax-free personal allowance of £11,850 (2018/2019).  If you earn more than £100,000 a year, your allowance is less. If you claim a marriage allowance or a blind person’s allowance it could be more.

Your taxable income includes your incoming money from employment, self-employment, property rentals, pensions and trusts. The more you earn, the more you pay within each band rate.

For example

  • Someone who earns £30,000 a year will pay 0% tax on £11,850 + 20% tax on £18,150 (£30,000 – tax free allowance).
  • Somebody who earns £50,000 a year would pay 0% tax on £11,850 + 20% tax on £34,500 (£46,350 – tax free allowance) + £3,650 (£50,000 – basic rate threshold).

Tax year 2018 / 2019

Band

Taxable income

Tax rate

Personal Allowance

Up to £11,850

0%

Basic rate

£11,851 to £46,350

20%

Higher rate

£46,351 to £150,000

40%

Additional rate

over £150,000

45%

Source: https://www.gov.uk/income-tax-rates

In the tax year 2019 / 2020 your personal allowance will increase to £12,500

Tax year 2019 / 2020

Band

Taxable income

Tax rate

Personal Allowance

Up to £12,500

0%

Basic rate

£12,501 to £50,000

20%

Higher rate

£50,001 to £150,000

40%

Additional rate

over £150,000

45%

Your taxable income may also include any interest earned on savings or bonds. But your savings allowance and ISA allowance, which we’ll come onto, can help to reduce your tax bill in this respect.

2. Personal savings allowance

As we’ve mentioned, interest earned on savings can count towards you taxable income. But, did you know that you also have a personal savings allowance in the current tax year of £1,000?

This means that only interest earned in excess of £1,000 would be taxed.

As an example, if you had £50,000 in savings held in a cash account with an interest rate of 2%, the interest rate generated in one year would be £1,000. Assuming you had no other savings in other accounts, this interest would be covered by your personal allowance, and there would be no income tax to pay.

For higher rate tax payers, this is reduced to £500. For additional rate tax payers, this amount is reduced to £0. If you have a joint account, the interest will be equally split between account holders. If you think that it should be divided differently, you can contact the government savings helpline for more information. 


3. Capital gains tax-free allowance

‘Capital gains’ are the profits you make when you sell applicable assets (and also when you give it to someone else or swap or trade it). Applicable assets include some personal possessions (if they’re worth more than £6,000), some property, and stocks and shares.

For the 2018/2019 tax year, your capital gains tax-free allowance is £11,700. That means that you’ll only pay capital gains tax on the profits of over £11,700.

As an example, if you had £100,000 in stocks and shares at the start of the tax year, and your investments grew by 11% over the year, you would have made £11,000 (minus any fees and charges), which would be within your capital gains tax-free allowance and therefore wouldn’t be taxed.

Above this threshold, capital gains can be taxed at various rates dependent on the rate of income tax you pay, as well as the type of assets you were profiting from.


4. Dividend allowance

If you own shares in a company, you may receive regular dividend payments – your portion of the company’s profits. The tax you’ll pay on dividends depends on which rate of income tax you pay. If you pay the basic rate (20%), you’ll pay tax on dividends at 7.5%. If you pay income tax at the higher rate (40%), you’ll pay tax on dividends at 32.5%. And if you pay income tax at the additional rate (50%), you’ll pay tax on dividends at 38.1%.

However, for the 2018/2019 tax year, you have a dividends allowance of £2,000, meaning that you only pay tax on dividends received above that amount.

So, if you’re a higher rate tax payer who received £5,000 in dividend payments in the 2018/2019 tax year, you’ll pay £975: 32.5% of £3,000.


5. ISA allowance

Another way to protect your interest income, capital gains and dividends from tax is by keeping your savings and investments in ISAs (individual savings account).

Savings can be kept in a cash ISA, while various types of investments, from individual company shares to investment funds and government or corporate bonds, can be held in a stocks and shares ISA.

For the 2018/2019 tax year, your ISA allowance is £20,000, meaning that you can make payments of up to £20,000 into whichever ISAs you choose to hold, and there will be no income tax, capitals gains tax or dividends tax to pay on any returns generated on that amount.

This is, of course, particularly useful if you have exceeded your other allowance; your personal savings allowance, capital gains tax-free allowance and dividend allowance.

But even if you’re currently within your other allowances, it’s worth using your ISA allowance as the current rules protect the money within that wrapper in all future years as well (though these rules could be subject to change). With a flexible stocks and shares ISA (such as the one offered by Click & Invest) you can withdraw money from deposited in previous years and still lock the allowance (as long as you repay it in the same tax year). This means that if you maximised your ISA allowance for 2 years and then withdrew everything, you would still have the option of putting it all back in (in the same tax year) without losing any tax breaks.

At moderate growth of 5% a year, someone investing their full annual allowance of £20,000 over the course of the next decade would end up with ISA holdings worth more than £250,000 – roughly £50,000 of which would be made up of investment profits. If the whole amount was then withdrawn, there would be no tax to pay on that £50,000 at that point.

Outside a tax-efficient stocks and shares ISA, on the other hand, and assuming a capital-gains tax allowance of £12,000, around £38,000 of that profit would be taxable – for higher-rate income taxpayers, this would mean a bill of £7,600.

The amount of tax you stand to save in a stocks and shares ISA – such as a Click & Invest Stocks and shares ISA – depends primarily on the performance of your investments: the more growth you achieve, the more you will benefit from holding your assets inside an ISA.


6. Pension annual allowance

ISAs are not the only tax-efficient saving option. Money you contribute to your pension qualifies for tax relief, which means it is treated as if it comes out of your pre-tax earnings. If you’re a basic-rate taxpayer, therefore, every £80 you put into a pension is topped up by HMRC to £100. Higher-rate taxpayers can claim an additional 20% tax relief via the self-assessment system, while additional rate taxpayers can claim 25% in the same way. This means that you if you are a basic rate tax payer, for every £80 you put in, you will receive £100. For higher rate tax payers, for every £60 you put in you will receive £100.

There is an annual allowance of £40,000 pension contributions on which this relief is available – and you can’t claim tax relief on contributions that exceed your annual earnings.

Bear in mind though that, unlike an ISA, money in a pension is locked up until age 55 under current rules. Pension withdrawals after that age are counted towards your taxable income. It may be worthwhile to explore your personal pension allowances as you consider your tax breaks and your future

Using your tax-free allowances

You have until 5 April 2019 to use each of these allowances for the current tax year. You can’t carry your allowance forward into the new tax year, so if you don’t use it, you lose it.

Some of these allowances are applied to your tax bill automatically, but when it comes to ISAs and pensions, it’s your responsibility to make sure you’re using your allowance and claiming back any tax relief you’re entitled to – so make sure you’ve planned your contributions before the deadline.

If you don’t have an ISA and would like one, take a look at the Click & Invest Stocks and shares ISA to decide if it might be suitable for your needs.

All investment carries risk and it is important you fully understand these risks and are willing to accept them. You may get back less than you invested. The tax advantages of ISAs may change in the future and also depend on your individual circumstances.

Click & Invest are not authorised or regulated to provide tax, legal or accounting services. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.

The information herein relates solely to UK regulations. You should consult your own tax, legal and or accounting advisors if you are unsure of your tax position.

 

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