DIY Retirement Stage 3 - The UK Tax System

I want to ensure that before I speak about retirement planning or indeed any financial planning, you have a basic understanding of the UK tax system of today. Obviously, this only applies for the tax year of writing this article (2020/21) if you’re reading this after, EVERYTHING has changed! Especially as during the pandemic we have built up a lot of new state debt. Therefore you should expect taxes and breaks to change a lot. Towards the next budget or indeed as early as September 2020.

Current Tax rates - England

1.      Inheritance tax: 40% on assets above nil rate bands (covered later)

2.      Income tax: -

a.      Personal allowance £12,500

b.      20% on everything up to Circa £50k, dependent on other allowances

c.      40% on £50-£150k

d.      45% on everything else

3.      Capital gains tax (CGT):

a.      10% basic rate,

b.      20% higher rate

c.      8% uplift in both if the gain arose from property.

4.      Dividend tax: (same thresholds as income tax however you get £2,000 PA dividend allowance)

a.      7.5% basic

b.      32.5% higher rate

c.      38.1% additional

5.      Tax on savings interest

a.      Taxed at basic rate

b.      Basic rate taxpayers receive £1,000 savings interest tax free

c.      Higher rate taxpayers receive £500

d.      Additional rate taxpayers do not receive any interest tax free

The above are the main taxes that most normal individuals will need to worry about.

National insurance rates are

1)     Class 1 (employee)

a)      12% on earnings from £9,500 - £50,000

b)     2% on earnings above £50,001

2)     Class 2 (self-employed)

a)      £3.05 per week if earnings are above £6,475 per year.

3)     Class 3 – Voluntary contributions which can be made if there is a shortfall in contribution years in your state pension

a)      £796 PA

4)     Class 4 – Self employed

a)      9% on earnings from £9,500 - £50,000

b)     2% on earnings above £50,001

Everyone can and should get a State pension forecast by going to and completing the online form. I would suggest you do this every 10 or so years and more often when you get closer to deciding whether to take or defer your state pension.

Let’s explain them in a little more detail.

IHT (inheritance tax)

IHT is the tax levied on your estate on your death. The government is due to receive £5.3 Billion in IHT for the 18/19 tax year. It may not shock you that most of that money doesn’t come from the super wealthy, as they plan for it. It also doesn’t come from the very poor, IHT is usually levied on the middle ground, the people who are liable but don’t really understand the system enough to plan against it.

To calculate IHT it is relatively simple, you add the value of all your assets up, take off £325,000 for a ‘nil rate band’ and all your liabilities (debt) the figure you are left with is your net assets. A little bonus is that your pension sums are actually not liable to IHT so as long as they are not going to your spouse, take them off as well.

In England we then also have the ‘residents nil rate band’ – this is a further £175,000 that is not taxable.

After both bands, pensions and any liabilities have been deducted the figure that’s left is taxed at 40%. The tricky thing is the bill needs to be paid before your beneficiaries receive their money, meaning they can use your money to pay the IHT bill.

All of the above means that the only ones who need to worry about IHT are people with over £500,000 worth of assets, couples with over £1M or those who do not/ have not owned property and have over £325,000.

The main issue now though is that most house prices are £300,000+ so your main residence will eat up most of the IHT nil rate bands.

Transfers between spouses are exempt from IHT, meaning you can transfer your entire estate on death to your spouse including your nil rate bands. YAY!

This isn’t always the best thing to do though… yes, they haven’t paid IHT to receive your money, but they have inherited your wealth which will likely continue to grow and possibly your pensions (remember they were not included for IHT).

The nil rate bands are only due to grow by inflation so they are not going to grow as quickly as the money inherited, no matter what it is doing it should be growing by more than circa 1%.

I will cover this point in more detail later on in further articles but with pensions, once they move from you to your spouse on death, the pension sums then become liable to IHT on your spouse’s death. For example your £250,000 pension pot which originally was not included for IHT moved to your spouse on your death by default and now, on their death is going to get taxed at 40%. That means your estate will lose £100,000 because of it!

Just in the last few paragraphs hopefully you can see where I would be looking as an adviser, not to invest your money for financial gain, but to ensure you are not losing £100,000 when there are simple quick solutions.

Income tax is levied on all earnings above the personal allowance, this is currently £12,500pa. Basic rate (20%) is levied on everything from £12,500 up to £46,000. Higher rate (40%) on £46k-£150k and additional rate (45%) tax on everything upwards.

The personal allowance taper is introduced on taxpayers earning over £100,000.

Dividend tax is applied in the same way as income tax against share income (Dividends) on annual distributions above the annual dividend allowance (£2,000). Therefore, dividend income just gets put on top of your income for the year and gets taxed accordingly. The rates for income and dividend tax are different, this is to reflect that corporation tax has already paid in the company prior to the distribution of profits.

Capital gains tax

CGT is levied against capital growth on assets, including property on their disposal. Your main residence is exempt from CGT. All other property and asset sales will be charged CGT.

To calculate a gain, you take the purchase price and any capital expenses made towards the asset from the sale price. The difference (the gain) is then liable to CGT. Everyone has a £12,300 CGT annual allowance which can be offset against any gain made that year. After the CGT annual allowance, the gain is put at your current tax band, if it falls within basic rate the tax charge is 10% and if it falls in higher or additional rates the levy is 20%. There is an 8% surcharge which applies to gains that arise from the sale of additional properties (not your main residence).  

There are reductions available against CGT including entrepreneur’s relief, but tax advice should be sought for any substantial gains you are about to make from accountants or tax advisers and goes well outside the scope of these articles.  

Now that we’ve gone through the basics of our tax system, we can now low at how we can use it to our benefit.

I would like to stress though, Covid 19 has got the treasury and the chancellor looking at pensions and their tax breaks with a magnifying glass, changes are expected, anticipated and highly likely.