Tax is important. We might not like paying it, but it’s fair to say we all like the benefits that government spending brings to society.
Not only does the tax system help pay for services that benefit the country and its citizens, but it also allows the government to incentivise certain behaviours. For example, the tax benefits available to investors who use pensions, encourages people to help fund their own retirement.
While the system is designed with the best of intentions, it’s so complex that it’s never going to be perfect. That’s why proper tax planning is a vital part of any plan for financial freedom.
We’re going to start with the basics in this article, because when it comes to tax there is a lot to get your head around. Over time we’ll cover different tax strategies to pay less taxes in more detail and go into more complex areas.
For now, let's look at some of the ways a family can structure their finances in order to make the most of the allowances the government provides, and in turn, pay less tax.
One of the most straightforward ways to do this for married couples is to balance your income, to take advantage of the way the tax system is designed. We’ll show you how.
The tax system in the UK is designed with individuals in mind. Unlike other countries such as the United States, where you’re able to file and pay taxes jointly, in the UK you are always assessed for tax on your own.
It’s the same regardless of the source of income. It could be from employment, self-employment, dividends or capital gains, and everything is assessed against the individual. For income or capital gains that are owned jointly, the gain or income is split for tax purposes based on the percentage that each person owns.
This creates a somewhat unusual scenario for some families. You can have one member of the couple who is a high income earner paying a very high level of tax, while the other half of the couple earns no income and pays no tax. There is no consideration for the fact that the sole income earner is financially responsible for both people, as well as any children.
The situation can be quite unfair if it’s not managed properly, but if you know how to structure things, it can be used to your advantage.
One of the first areas to look into is income tax from employment or self employment income. We’ll consider two different families. Family One has one member of the couple who is the main income earner, and the other who earns no income.
For simplicity's sake, we’ll make the breadwinner a salaried executive, with income of £250,000 per year.
In very broad terms, they would expect to take home around £140,000 of this salary once tax and national insurance are taken into account. That’s a sizable tax bill of £110,000.
Now we can look at Family Two. This couple both earn an income of £125,000 each, bringing the total household income before tax to the same £250,000 as Family One.
The difference is that they’ll pay less tax. Combined, they would expect to pay around £100,000 in tax, saving themselves around £10,000 per year. This might not seem like a groundbreaking amount, but if you invested that each year over the course of 10 or 20 years, it would add up to a significant sum of money. You could even direct this saving into an investment fund for your children. In our article here we show you how it can completely change their lives.
The key point is really about the opportunity for equalising incomes. It’s an important consideration for couples looking to start a family, and for those who are self-employed it’s also a big opportunity to divide the income between spouses.
That’s all well and good if you have the flexibility to structure your finances between each member of a couple, but some don’t. Certain industries or professions don’t lend themselves to the right kinds of roles that would allow both members of a couple to work flexibly while still earning good money.
Regardless of the financial aspect, it may also be a personal choice for one member of the couple not to work. If this is the case, there are still some important tax allowances to take advantage of.
That’s because taxable income isn’t just income from a job or from self-employment. Interest from bank accounts, dividends from shares and capital gains from the sale of assets are all potentially taxable.
The tax on these can be very high, particularly if the assets are held in the same of someone who's a Higher Rate or an Additional Rate taxpayer.
That’s why it can be very beneficial to hold income or capital gains generating assets in the name of the lower earning partner. This ensures that they are using their allowances, such as their personal allowance, dividend allowance and savings allowance. These are all amounts from different income sources that can be earned without the need to pay any tax at all.
Splitting assets between spouses not only takes advantage of the tax free allowances, it can also help reduce the tax burden for amounts that go over these allowances. If both spouses have used up all of their tax free amounts, but one is a Higher Rate tax payer at 45% and the other is a Basic Rate tax payer at 20%, it can be hugely beneficial to hold more assets in the Basic Rate tax payers name. It won’t avoid the tax altogether, but it can reduce it significantly.
Importantly, you can also transfer assets between married spouses without triggering any capital gains tax. This means you can find the optimal mix for whose name the assets are going to be in.
Now you have an idea of some of the types of strategies you can use to pay less tax, it’s time to take action. Here’s a list of the actions you can take to improve your financial efficiency.
Summarise the income of the household and who receives what.
Create a list of your assets and who legally owns them. We have a financial questionnaire that makes this super simple, and you can each create a personal profile here.
Review the results of the Rosecut financial achievements and wellness tool. In just 5 minutes, you’ll have an assessment of your current situation with ideas and guidance on what you can do to improve your tax efficiency.
If you want to discuss this in more detail with us, book a time for a call and we’ll lay it all out for you.
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