How to avoid overpaying tax using tax allowances

No one wants to give away more of their money than they really need to. In the UK, our tax system is a complex structure that runs on a non-linear path. It’s easy to take a wrong turn if you’re not treading carefully – especially as your earnings escalate.

To make sure you’re not overpaying taxes, a good place to start is by checking where you currently stand on your allowances. This blog guides you through:

• How to use your allowances to avoid overpaying tax
• What are the UK tax allowances?
• Which allowances can you carry forward?

Let’s look at four of the UK’s tax-free thresholds that can be used to reduce how much tax you owe.

1.  ISAs

Every tax year you can save up to £20,000 in total in your ISA or across multiple ISAs. Any money inside grows free from income tax and capital gains tax. For example:

• If you put £20,000 into a stocks and shares ISA
• Your investments then grew by £2,000 over the year
• You would pay no tax on the £2,000 growth

(figures are illustrative, not guaranteed)

Maximising your tax-efficient ISA allowance each year means you take full advantage of this tax break. The type of ISA you choose will also have an effect on your finances.

Cash ISA

Your cash ISA is a tax-efficient, instant access savings account. Many people use this type of account to hold their emergency fund, but holding more in a cash ISA than you need immediate access to could be detrimental to your financial progress.

Inflation will counter even a relatively high interest rate, meaning that savings kept in a Cash ISA for extended duration could lose value in real terms.

Stocks and shares ISA

If you’re able to invest in a Stocks & Shares ISA over the long term, this money has the potential to beat inflation over time. Variation will be seen throughout the investment due to the natural short-term ups and downs of the stock markets, so it usually takes at least five to ten years to reap the true benefits.

Junior ISAs

JISAs allow you to save money for any child up to the age of 18, with any returns currently free of Income Tax and Capital Gains Tax. All money deposited is a gift to the child and tied up until they reach 18 years of age. This means it falls out of your estate after 7 years, which could also help mitigate Inheritance Tax. A parent or legal guardian must set up a JISA but after that anyone can contribute. 

2.   CGT Allowance

The Capital Gains Tax annual allowance currently sits at £3,000 for individuals and £1,500 for most trusts. If your total gains after deducting any losses stay below this threshold, you will not pay CGT. For example:

• If you sell shares and make a gain of £2,900 in the tax year
• And you have no other gains or losses
• Because this is below the £3,000 CGT allowance, you’ll pay no Capital Gains Tax

This is a ‘use it or lose it’ allowance, meaning it does not carry forward from one tax year to the next. It often makes sense to plan disposals so you realise gains up to but not exceeding £3,000 each year, therefore maximising the allowance.

CGT rates currently stand at 18% for basic-rate taxpayers and 24% for higher and additional-rate taxpayers on most assets. Taxation rates can change at any time.

3.   Savings Allowance

The personal savings allowance means you don’t have to pay tax on some of the interest you receive from your cash savings accounts.Your annual allowance is based on the rate at which you pay Income Tax:

• £1000 for basic rate taxpayers
• £500 for higher-rate taxpayers
• £0 for additional rate taxpayers – all interest subject to tax

This means that as a basic rate taxpayer you can hold £20k in a cash savings account that pays 5% annual interest before paying any tax on the interest. Higher-rate taxpayers can hold up to £10k (figures are illustrative and not guaranteed).

Because the allowance applies across all of your cash savings accounts, it can help to plan how your savings are held so you don’t exceed it. For example:

If you have two cash savings accounts:

• Account A: £10,000 at 3% = £300 interest per year
• Account B: £15,000 at 5% = £750 interest per year
• Your total interest received would be = £1,050

As a basic-rate taxpayer, your allowance is £1,000, so £50 of your interest would be taxed. If you moved £5,000 from Account B to an ISA, your interest drops to £1,000, all shielded from tax.

4.   Pension Contributions

Often considered the best way to save for your retirement, pension contributions are especially powerful. Eligible contributions receive tax relief, which means some of the money that would otherwise go to Income Tax is added to your pension pot instead. For example:

• If you’re on 20% tax and pay in £80
• HMRC will add an extra £20
• Making your total pension contribution £100
  
  

You get the double benefit of more funds saved for retirement without extra cost, plus compound interest gained over time.

The total amount that can be paid into your pension, including from your employer, is limited to an annual allowance of £60,000. You can carry your annual allowance forward if you haven’t used it all in the previous three years.

Currently most pensions are exempt from IHT, but it’s worth noting that from April 2027, pensions are likely to be included in the value of your estate and therefore may be subject to Inheritance Tax.

The value of your investment can go down as well as up. You could get back less than you invested.

Which allowances can you carry forward?

You can carry forward any unused annual pension contribution allowance from the previous three tax years, provided you were a member of a pension scheme in those years.

Carrying forward pension allowance can be useful if:

• Your income fluctuates
• You want to make a larger one-off contribution
• You’re looking to maximise tax relief in a year where your earnings are higher

Which allowances are ‘use it or lose it’?

Most allowances must be used within the tax year and cannot be carried forward. This applies to:

• ISA allowance
• CGT allowance
• Savings allowance

These allowances apply only to the current tax year, hence the common label of ‘use it or lose it’.

How to avoid overpaying tax using tax allowance

Staying aware of your full scope of options is key at every stage of financial planning.

At Keyplan Wealth, we help our clients reach their life goals through tailored financial plans that make the most of every opportunity. Our aim is to keep you fully informed to make confident decisions when managing your wealth.

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The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.

An investment in equities does not provide the security of capital associated with a deposit account with a bank or building society, as the value; income may fall as well as rise.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

Please note that St. James's Place does not offer Cash ISAs.

Although the content of the article was correct at the time of writing, the accuracy of the information should not be relied upon, as it may have been subject to subsequent tax, legislative or event changes.