With constant reports of incomes being squeezed, house prices rising, and new fears about inflation ticking upwards, are you making the most of your money? In my opinion, the most efficient way to generate an income is to utilise tax-free allowances to maximise your tax-free income. To those that follow personal finance, you’ll know that ever year the UK Government allows UK citizens to earn a certain level of income without paying any tax.
Individuals across the political spectrum rarely agree on why particular allowances exist; some people view them as a right wing scheme to allow the rich to get richer, others as an unaffordable luxury, and I’ve even heard of some individuals who see it as a pointless shuffling of funds to subsidise low earners who would be better served by pushing for higher wages than by existing on tax credits.Regardless of your view on the topic, allowances exist and are set to continue for the foreseeable future. In this article, I’ll look at how you can make the most of your money by maximising your tax-free income.
Maximise your tax-free income with Personal Income Allowances
For the 2016/17 tax year, the individual personal allowance is set to be £11,000 a year, or £916.66 a month. Not exactly millionaire territory, but still a healthy starting point. Ignoring projections of state benefits, and the tax-free implications of an ISA, this means that if you took an income of £11,000 today, you would pay no tax.
For every £1 above that figure, you paying income tax, effectively reducing your income by 20% (or more). In my opinion, it’s better to pursue tax-free allowances first than try to save ever greater sums of capital for an ever decreasing return. Presuming you had £550,000 in retirement, a 2% withdrawal rate would support £11,000 worth of income.
If you acquired this value of capital and were confident that you could avoid more than a 2% withdrawal rate, you could retire and start withdrawing an income of £11,000 a year immediately.
If you’re sat scratching your head and pondering how on earth anyone could survive on just £11,000, read on.
With a raft of recent changes to the UK Tax code, the opportunity to maximise your tax free income is actually far greater. In addition to the £11,000 personal income allowance, UK individuals are also able to access the following allowances to make the most of their money;
- £1,000 personal savings allowance
- £5,000 nil-rate band
- £5,000 dividend allowance
- £11,100 capital gains allowance
- £25,000 pension withdrawal
- £40,000 income from ISAs
Obviously, there are a few caveats to these allowances; for example, the £5,000 nil rate band is only available to those with an income of less than £11,000 per annum.
In addition to this, earning £40,000 from ISAs seems a little optimistic for most taxpayers. With rates barely scraping 1% a year for most cash ISAs, you would need £4,000,000 saved. Whilst an S&S ISA might yield higher rates, these are not guaranteed and so returns would vary.
A share portfolio of £120-140,000 should yield dividend payments of £5000 a year. Although this sounds like a lot of money, saving just £7,000 a year (just under £600 a month) will net you this sum in 20 years. These shares could also appreciate in value to provide part or all of your yearly capital gains allowance.
Other holdings which could count towards this allowance include business assets, any property that isn’t your main residence and personal possessions worth more than £6000 (apart from your car). These might include valuable jewellery, paintings, antiques, coins, stamps and other collectable items.
Presumably, it would be difficult to acquire this capital gains appreciation year after year without significant assets to start with, but it is (in theory) possible.
Making the most of your income
Once you add these allowances together, you end up with tens of thousands of pounds which can be drawn as income every year – entirely tax-free. In an age when finances are being squeezed, it might not be a terrible thing to look to these allowances to maximise your tax-free income.
Taking responsibility for your financial future is an important part of life. You need to work hard to make the most of your income; saving and investing wisely. If you enjoyed my article on how to maximise your tax-free income, you might also enjoy this article on sourcing investment opportunities or this article on generating a passive income.