Tax Freedom Day – 6 ways you can you bring your own personal Tax Freedom Day closer
Tax Freedom Day was devised by the Adam Smith Institute as a benchmark for when the average person has paid all their tax for the year, and starts earning money for themselves instead of the government.
In the UK, Tax Freedom Day currently falls at the end of May – around 40% of the way through the year, and over a month later than in the US! That means that on average, our first 148 or so working days are simply covering the tax we’ll pay over the course of the year.
It covers an estimate of your income tax, national insurance, a proportion of corporation tax receipts, VAT, insurance premium tax… basically all the taxes you can think of.
Of course, some are higher earners and have a personal Tax Freedom Day later in the year; and non-earners will have theirs earlier.
Collectively in the UK, we generate over £700bn in taxes for the treasury each year. That’s the revenue that keeps our country’s services running.
But can you – morally, legally and ethically – bring your personal Tax Freedom Day forward earlier in the year? Here are some things to check that might just do that for you.
1. Income Tax
The first place to start is on the money you earn: income tax.
Income tax rates are:
- On our first £12,500 annual income, we pay no tax
- The next £37,500 we earn, we pay 20% income tax
- The next £100,000 we earn is taxed at 40%
- Anything over £150,000 of income is taxed at 45%
In addition, we pay National Insurance contributions:
- On our first £8,632 income, we pay no NIC
- Between £8,632 and £50,000 of income, we pay 12% NIC
- Over £50,000 income, we pay 2% NIC
For example, someone on just under £50,000 per year is effectively paying 32% tax on a sizable portion of their earnings. (Rates are lower for the self-employed.)
It’s important to be aware of the tax you should be paying. You’ll receive a tax code each year: if yours isn’t a standard code, then contact HMRC and challenge them as to why. Mistakes can be made, so check your code on your payslip.
2. Pension contributions
Pension contributions receive tax relief: you get your income tax back on them.
- If you’re a basic rate taxpayer (under £50,000 annual income), this gets automatically added to your contributions.
- If you’re a higher rate taxpayer, you have to claim back the extra amount through a tax return.
If you earn more than £50,000 annually, and you’re making personal pension contributions – i.e. not those made by your employer – you need to ensure you’re claiming the higher rate tax relief from HMRC. It is NOT given to you automatically.
This is one of the most common ways higher earners could bring forward their Tax Freedom Day; so many are not aware or do not claim it. If you get a bonus at the end of the year and it takes you over £50,000 in income, then it’s very easy to miss this.
One more thing: if your employer offers you salary sacrifice (sometimes called salary exchange), then you should take it. This sees you give up some of your salary, which is instead paid into your pension.
Why should you do it? Because it’s more tax-efficient – you’re saving on NI contributions. (A caveat might come if you are looking to take out a mortgage soon.) The numbers may seem small, but over the long-term, which a pension is, they really add up thanks to our old friend compound growth.
3. Charitable Contributions
Typically, you’ll get basic rate tax relief added on to any charitable contributions you make through the Gift Aid system.
But you can claim the higher rate back yourself as well if you’re a higher rate taxpayer, through a tax return, in exactly the same way you can with pensions contributions.
4. Marriage Allowance
This benefits couples where one partner is a low earner or has no income. If one person in a marriage doesn’t earn more than the £12,500 personal allowance – i.e. pays no income tax – they can transfer 10% of their personal allowance to their spouse.
A non-earner can transfer £1,250 of their allowance to their husband or wife, which will save £250 per year in tax.
It’s straightforward to claim, but it’s not automatic. It’s hugely underutilised, with HMRC stating that less than 1 in 10 of eligible couples are making use of this allowance.
5. Work Allowances
If you’re doing mileage at work, you can claim 45p per mile up to 10,000 miles, so if you’re not receiving that then you should claim the difference.
You may be eligible for up to £208 of tax relief If you have to (not choose to) work from home. You can usually claim this back online and check what you can claim for – it must be business-related, but cannot also cover things you use personally such as broadband.
The best thing to do if you think you have allowances you can claim and don’t want to do all the research yourself is to find a good accountant and pay them for an hour of their time. You should save more than they cost!
6. Inheritance tax (IHT)
Everyone has a £325,000 tax-free allowance to leave behind. If we leave our estate to our spouse, they add their own allowance and can leave £650,000 without IHT.
A few years ago, the main residence nil-rate band (AKA the Principal Private Residence Allowance) was brought in as an additional allowance. If you have a main residence (your home) which passes to your “direct descendants” – basically, your spouse, children or grandchildren – no IHT is due on the first £150,000 of value, rising to £175,000 next tax year.
Those figures were set because when you add up the £325,000 estate allowance and the £175,000 from your home, as a couple that means you can leave up to £1m without incurring inheritance tax.
A final note here: if your will includes a discretionary trust, then you should get it checked over by a professional, because some of those wills were written in a way that you won’t qualify for the PPRA.