The UK has a reputation for having a complicated tax system. For many people in this country, it can represent more of a headache than an opportunity. No one wants to pay more tax than they should, but time after time people fall into the same tax traps and end up paying the price for it. Even the most financially literate among us can be a victim of the UK’s many tax rules and regulations – it’s like trying to navigate a thousand-page book that is constantly changing.
Whilst the entire list of tax traps to avoid would be a long one, we have summarised some of the most common tax mistakes to be aware of.
Not splitting the load
A lot of tax allowances, exemptions and tax-efficient investment opportunities can be used by both people in a couple, allowing both parties to maximise the benefits. For instance, if just one person in a couple has taken advantage of their ISA allowance for the tax year, they can gift some money to their partner who has some or all of their allowance left. When considering Capital Gains Tax (CTG), the same approach can be taken.
Failing to prepare
It’s a very easy habit to get into: only paying attention to your allowances only at the start and/or end of each tax year. This can mean it may be too late to use them, particularly Income Tax allowances and exemptions that can’t be carried forward.
Taking your tax-free cash lump sum in one go
Another mistake that people often make, particularly people reaching retirement and accessing their pension, is to take all their tax-free cash at once when it’s not needed and put it into the bank. If you have a Defined Contribution (DC) pension, you could use some of your tax-free cash year as a substitute for income, which means drawing less from your pension and being tax efficient. If you don’t need the full amount straight away, give some thought to taking it in tranches when you need it. If you leave it invested, it could potentially continue to grow.
Turning down free money
It’s surprising how many people forget (or decide not) to reclaim payments to which they’re entitled. For example, some higher-rate and additional-rate taxpayers fail to reclaim the pension tax relief they’re due, while the tax relief offered on gifts to charities can also be overlooked. This can be done via self-assessment or by calling HMRC with the figures.
Not reviewing annually
One pitfall is not seeing that a lot of potentially sizeable tax-saving opportunities come around every year. These include the £20,000 ISA allowance, the £2,000 dividend allowance, and the £12,300 CGT allowance, all of which are lost for good if they aren’t used during the tax year. If you are not taking advantage of these ‘use it or lose it’ opportunities, you could be missing out.
Having the 60% rate catch up to you
When it comes to earnings between £100,000 and £125,140, there is effectively a 60% tax rate. That’s because if you earn £100,000 or more, your £12,570 personal allowance is reduced at a rate of £1 for every £2 above £100,000. So, for every £100 of income between £100,000 and £125,140, you will only take home £40, with £40 taken through Income Tax and another £20 lost due to the gradual removal of the personal allowance, which adds up to an effective tax rate of 60%. Perhaps the most common way to reduce this is to reduce your taxable income by making the most of your pension contribution allowances.
Avoid tax traps by preparing
When it comes to tax pitfalls, it all comes down to planning and preparation. The best way to do this is with the help of a professional financial adviser.
When looking into tax-saving strategy, it is always best planned before the tax year starts, so that it can be executed in a structured way throughout the year. The alternative is to leave it to the last minute, when some opportunities might no longer be available.
A great way to ensure that you at least consider all of the opportunities to minimise your tax bill is to have your adviser run through a tax health check with you.
If you found Unexpected tax traps and how to avoid them helpful, you’ll find more about managing tax liability on our Finance channel.
About the Author / Tony Clark
Tony Clark, Senior Propositions Manager at St. James’s Place. Tony specialises in retirement, tax planning and social care.
