2. Contribute to a pension
When an individual makes a contribution to a personal pension (other than via salary sacrifice), they can be eligible for tax relief at their marginal rate. As with donations made under Gift Aid, a taxpayer’s basic and higher rate tax bands are extended by the grossed up pension contribution so that they obtain tax relief at their marginal rate. Relief is limited by the lower of your annual earnings and the annual allowance.
The standard annual allowance for gross pension contributions is £40,000 gross, subject to the level of your income. However, for those with income in excess of £150,000, the annual allowance is tapered down to a minimum of £10,000 (gross) by £1 for every £2 of adjusted income in excess of £150,000. Pension contributions in excess of the annual allowance are subject to the annual allowance charge. This effectively claws back the tax relief.
One important thing to note, is that you can carry over any unused annual allowance from the three previous tax years as long as you were a member of a pension scheme in those years. Therefore, it is important to review your position and take appropriate action to maximise your pension contributions by 5 April 2020, after which any unused allowance from 2016/17 is lost.
Preserving your personal allowance
It is not unusual for individuals who earn between £100,000 and £125,000 a year to find that they have an unexpectedly high marginal rate of tax.
This is because the tax-free personal allowance (£12,500 for 2019/20) reduces by £1 for every £2 of income above £100,000. Therefore, those that earn £125,000 or more during the year do not receive a personal allowance at all. Taxpayers who have annual salaries or pension income below £100,000 will generally have received the personal allowance by application of their PAYE code. However, if they receive other income (e.g. bonus, interest, dividends) that pushes them above this threshold, some or all of the personal allowance will be lost and tax will be payable on the withdrawn relief.
Gift Aid donations and personal pension contributions have the effect of extending the £100,000 threshold, such that the personal allowance is restored by £1 for every £2 donated to charity or invested into a personal pension. The combined effect of the extended basic rate band and the restored personal allowance gives an effective rate of tax relief of 60%.
3. Invest in a Start-Up Company
i. Enterprise Investment Scheme (EIS)
From 6 April 2018 the EIS allowance has effectively doubled. It is now possible to invest up to £2 million in EIS, provided anything over £1 million is invested in “knowledge-intensive” companies. These are companies that carried out research, development or innovation at the time they issued, or are issuing shares. You receive an income tax deduction of up to 30% of the EIS investment and have the option to defer capital gains on assets disposed within a certain timeframe, equal to the amount invested.
ii. Seed Enterprise Investment Scheme (SEIS)
You can invest up to £100,000 in the year and receive an income tax reduction of 50%, potentially wiping £50,000 off your income tax bill. Furthermore, you can claim to treat 50% of a capital gain as exempt from capital gains tax in the year you make the SEIS investment (i.e. a gain of up to £50,000).
IMPORTANT: Don’t forget that it is possible to carry back any EIS/SEIS subscriptions made in the current tax year to 2018/19, providing the EIS/SEIS limit has not been exceeded in that year. As the 2018/19 Self-Assessment filing and payment deadline has now passed, this will generate a tax repayment.
iii. Venture Capital Trust (VCT)
A Venture Capital Trust might be suitable for you if you are prepared to invest in higher risk funds. You can invest up to £200,000 in a year and receive an income tax reduction of 30%. However, unlike EIS or SEIS, there is no carry back.