If you go out and work hard for a living as an Average PAYE Joe then I'm firmly with your current scoffing. These guys and girls are I agree taxed heavily here in the UK. 20%, 40% and 45% are the well known tax rates. On top of this you have the less well known effective 60% tax rate that is in play once you earn a £100,000 until you've lost all your personal tax-free allowance. We also shouldn't forget about 12% employee and 13.8% employer national insurance contributions which are just taxes via another name and which add onto those well known tax rates. It’s a very tax hungry country for a worker.
Let’s however now enter the world of FIRE (financially independent retired early) or even just Retired. What can you now ‘earn’ and not pay tax on (of course these rules also apply to PAYE workers):
- From 06 April 2016 the personal tax-free allowance for earnings will be £10,800. The Tories have also stated that they will increase this to £12,500 by April 2020. Only after that are we into the 20%, 40% and 45% tax discussion. Our retiree's pension drawdown will be considered earnings so will be taxed according to this.
- From 06 April 2016 the current Dividend Tax Credit will be replaced by a new £5,000 Dividend Allowance meaning you will be tax-free on the first £5,000 of your dividend income no matter what non-dividend income you have. So let’s say our retiree has non-tax sheltered shares that are giving 4% in dividends per year. They could have share wealth of up to £125,000 outside any tax shelter and be tax free on all the dividends.
- Similarly from 06 April 2016 a tax-free Personal Savings Allowance of £1,000 (or £500 for higher rate taxpayers) on the interest that you earn on your savings will come into play. At current interest rates that allows a lot of capital in savings accounts outside tax shelters before tax comes anywhere near. Perfect for somebody like myself who intends to live off the dividends in FIRE and needs a cash buffer.
- On top of this you can also take whatever you've accrued within your ISA’s tax free. This could be a substantial sum. I started investing in ISA’s late and even though I’ll FIRE relatively early I still expect my ISA pot to be £150,000 or so at the point of FIRE. Take 4% in dividends/interest/capital from there and you have another £6,000 or so of ‘income’.
- If you need to do any non-tax sheltered tinkering then also don’t forget about the capital gains tax-free allowance. That’s another £11,100 for tax year 2015/2016.
- Then finally the icing on the cake. Our retiree is not exposed to National Insurance contributions but they can get free healthcare at the point of use.
As I work towards FIRE I'm also trying to avoid (remember avoidance is legal, evasion isn't) as much tax as possible. This includes salary sacrificing into a pension meaning I’m saving 20%/40%/45% tax plus both employees and most of the employers (my company adds 10% of the 13.8% to my pension) national insurance contributions now in exchange for paying tax on it during withdrawal. As I mentioned above I’m currently planning (and of course the rules have a habit of changing regularly) on that later tax rate being 0%.
Government are currently considering tinkering with this and the tinkering could very much affect the level of avoidance via a pension that a 40%/45% taxpayer like myself can achieve going forward. I would encourage everyone to read Merryn Somerset Webb’s article ‘Our stupidly complicated pensions regime’ in this weekend’s Financial Times (I have a deal with the FT where if you click through on the link provided you should be able to freely see the article). She summarises far more succinctly than me but surmises that instead of that 40%/45% tax deferral ‘we will probably end up with an incentive worth in the region of 30p in the pound’ which will not be called ‘a tax relief but a top-up’.
At budget time it was clear that something was up and I personally have positioned myself to really maximise the amount of salary I’m sacrificing into my pension this tax year, at the expense of cash savings for a family home, with the full expectation that I’ll then heavily reduce pension contributions next year when pensions are less attractive. They’ve already started by stating that next year the annual contribution allowance will be reduced to between £10,000 and £30,000 depending on your earnings but as Merryn highlights there looks to be much more to come.
I personally expect to nearly sacrifice £40,000 into my pension this financial year. It’s worth also remembering that this 2015/2016 tax year there is a quirk in the annual contribution allowance. As a reminder it looks like this:
- If you have contributed less than £40,000 to your pension between the 06 April 2015 and the 08 July 2015 (budget day) then these contributions do not count towards the current year’s £40,000 allowance. Effectively this means you have a new £40,000 allowance from the 09 July 2015.
- If you made a £40,000 and £80,000 contribution during that time your current allowance is £80,000 minus these contributions.
- If you made a contribution of more than £80,000 then you don’t have any remaining allowance. That said don’t forget you might be able to add more using the carry forward rules.
As always DYOR.
What a brave post, and I completely agree with you, except that I would prefer to use the words "tax planning" instead of "tax avoidance".
ReplyDeleteRules in Australia are similar, with a tax free allowance of approximately $20k. So, seek professional tax advice to structure your investments correctly, and you won't have to pay any tax in retirement.
Fortunately, as an about-to-be-retired tax accountant, I've been able to structure things correctly.
You forgot about VCT and EIS tax breaks, which I've mentioned to you a few times on HPC.
ReplyDeleteI have a modest five-figure income in VCT dividends. It pays the rent on a house that would cost twice what this investment cost me. And it's better than merely tax-free: it's explicitly exempted from my having to declare it on my tax returns.
What would you recommend as the best way to access VCTs? I am always put off by the front load fee and high management costs. Working out which fund to back is no picnic either
DeleteVCT eligibility rules are changing to make them invest in less mature companies. They aren't quite as attractive as they used to be
DeleteI understand that you could draw your pension income tax-free as a Portuguese resident. I suppose that would be pretty attractive for people drawing a Final Salary pension that would be taxed in Britain. How about the Isle of Man: is their deal good? Or Guernsey?
ReplyDeleteJust want to share a trick one can use from the next year.
ReplyDeleteLet's say you have a saving account, make sure you own it with your wife.
Now, if you are higher rate taxpayer and you wife is not, that calculate your interest payment and submit Form 17 and the statement of trust which will state proportionate split of the interest to maximize tax free interest.
For instance, you expect 2k interest in 2016, you need to submit Form 17 with your share being 25% and your wife 75%.
Then, the first 1000 will be tax free as your wife's, 500 as yours, and the rest 500 will taxed based on low rate of the wife, 20%. So, the actual tax rate is just 5%.
Enjoy
For those of us without wives I can confirm this method works just as well with someone who is not your wife
DeleteI'm glad they are aligning PIPs with tax years, it cause me no end of head scratching before I understood it and aligned mine a few years back. I'd not heard of the transitional arrangements being so generous, good to know given I'm right at the £40k limit due to a employer happy to write a salary sacrifice friendly employment contact, so I could do a top-up from rump pay as a last hurrah before the rules change.
ReplyDeleteI'm not clear how changing tax relief could affect sacrifice schemes, as currently they are just gross payments, and no assessment is made of 20/40% tax bands. If they introduced a flat 30% rate, would the sacrifice have a clawback tax charge for higher rate payers, and a 10% government contribution for standard rate ones? John B
Totally agreed, I don't know what most people are complaining about when they moan about taxes. I find the people that do are normally high earners + high spenders. If you are a high level consumer you should be paying high taxes, get over it! The choice it yours.
ReplyDeleteUnder the money tree had a similar example to this a few months back, I think he got the total up to £38,000 although that might have also been for a couple. It really does open your eyes to how easy we have it, if you, well open your eyes I guess (and read blogs such as this one!) :)
You think that high spenders should 'get over it' but what about high earners wanting to maximise pension contributions through deferred gratification, and retire early before their bodies are incapable of much enjoyment? Should that not be a choice? The amount the annual pension allowance has plummeted in the last few years is huge compared to the way the other tax free options have increased. RIT is a medium-high earner but very low spender. I am sure he is very relieved he already has acquired most of the pension pot he needs for retirement. So yes, great news if you already have the fat pension pot, but what about if you have a long way to go?
DeleteAnd free healthcare? In my experience, if you have a loved one, you are the one going to have to look out for them in an NHS hospital; there are a lot of cracks.
I think that if you are earning enough money to save up £40K/year to put into a pension you haven't got much to complain about, whether those savings are part of a tax advantaged account or not.
DeleteIs that something you seriously think is fair to complain about?
If so I suggest you take a look at this:
http://www.globalrichlist.net/
Maybe if we didn't all do so much tax "planning" (and I include myself here - no offence intended) there wouldn't be so many cracks in the NHS. It does trouble my conscience, but not as much as it should, I know.
Delete@thefirestarter. I am not complaining much about the pension allowance now but I do fear how low it will go.
Delete@Jim F
DeleteOn one hand you complain about having to pay tax today and not being able to defer it till you retire
On the other hand you complain about the NHS
The largest single element of discretionary expenditure (assuming you think things like defence and schools are necessities) are pensions and health
Your tax breaks are directly correlated to lower health spending
I did not complain about the NHS. I simply advised people to pay close attention to their loved ones in hospital. My Father nearly died in hospital after contracting an infection after an appendix removal operation. No infection (flesh eating bacteria) had been detected by the staff by the time I visited him sweating buckets and delirious, and pointed this out. He was in intensive care for two weeks. A friend of my Father's rolled off a hospital bed and died on the floor from the facial injury sustained; it is unclear how long it took someone to find him. I was in hospital for a condition and was released before the situation had resolved with no suggestion from the consultant of a follow up appointment who told me everything was back to normal. We can only go from our experiences and I do know that many doctors, nurses and support staff work extremely hard and I am grateful.
DeleteI responded to RIT's point that we have free healthcare. But also, in response to your point, throwing money at government funded organisations does not, in my experience, necessarily result in proportionately improved performance. It depends how many incompetents, committees and sloping shoulders get paid first.
The NHS killed my father-in-law. True the old boy was frail, but they gave him MRSA ,as the registrar admitted. The consultant denied it, of course, not knowing that his registrar had blurted it out. I don't know whether they cost him a year of life or a month. They did give us one laugh: they put down cause of death as "old age".
DeleteI cannot get that FT link to work without signing in but I googled the title and you just have to answer a simple marketing question to see it.
ReplyDeleteThanks for the info on pension changes; I was not aware of the 6/4/15-8/7/15 'giveaway'.
Why stop at £40k this year, RIT? Are you not worried the carry-forward rules will change or have you maxed out the last 3 years as well?
In the last budget the rent-a-room allowance was increased from £4,250 to £7,500 per year, so this means you can earn £625 each month tax free by renting out a room in your house, or perhaps an annexe so you can retain your privacy. If you choose the right property as your "forever house" then that's a pretty impressive return on investment even if you have to pay for an extension to be built.
ReplyDeleteWhy is the £5,000 interest tax free not in the list. a FIRE will not have non-savings(excluding dividend) income.
ReplyDeleteThe FT link doesnt work it just leads to a sign up page.
ReplyDeleteAlso you have a huge google cookie warning obscuring the top of the page
Search for "7b127d32-6dd2-11e5-aca9-d87542bf8673" in google, and click the link
DeleteLove the blog, but I would be careful with any generalisations over the Dividend Tax Credit; after all, the net effect will be to increase the Chancellor's Coffers!
ReplyDeleteFirstly, the Dividend Tax Credit is not re-claimable; it's merely an acknowledgement that 20% tax, in the form of Corporation Tax, has already been deducted. In the meantime, all dividends (after the first £5k) will be taxed at 7.5% / 32.5% (basic/higher rate). Under the old system, you could offset 10% against the 32.5%, but no longer from 2015/16. The £5k allowance itself is included within the basic/ higher rate tax bands, and is NOT a separate allowance.
Confused - I think that's the idea. For anyone for whom dividends (outside a tax-free wrapper) forms a significant part of their income, the net result is likely to be additional tax. Check out the Dividend Tax Calculator over at contractorcalculator.co.uk for a comparison of before vs after