In part-1 we considered the difference between tax evasion and tax avoidance and in particular the simple and effective ways to reduce tax via the annual pension and ISA allowances... Philanthropy makes it possible to reduce your liability to higher-rate or additional-rate tax by giving more to charity, an area we will consider more when the Purposeful Wealth podcast considers the subject of Giving.... For instance, if you’re earning over £100,000 a year, you lose your personal allowance by £1 for every £2 that your taxable income is over £100,000. In 2022/23, this means you lose your allowance if your taxable income is above £125,140. Your Financial or Wealth Plan might reveal you can afford to gift £20,000 to charity, perhaps your church, and because of Gift Aid, that charity receives a gift of £25,000. As you have gifted £20,000 and the charity has received £25,000, your adjusted income is now deemed to be £100,000; however, your net income has only reduced by around £9,500. Essentially, when you donate to charities, you can claim Gift Aid (if you’re a UK taxpayer) and when you do that you’re able to record your donation as a gift on your tax return, which reduces your liability to higher-rate and additional-rate tax, as well as potentially retaining your personal allowance. It’s an entirely legal way to avoid paying some of your tax, yet support causes you care about.
Now onto the subject of investing to reduce tax, however a word of caution, don’t put the tax cart before the investment horse though When it comes to tax it’s important to make sure that you don’t pay more tax than you need to and that you legally minimise the impact tax has on your wealth and financial future. However, the challenge comes in not putting the tax cart before the investment horse, so to speak. People can get so focused on reducing their tax liabilities that they make risky investment decisions and take investment risks, which their Financial Plan reveals they are not able to take and don’t need to take. For example, some people might put money into what I would call higher-risk tax planning products, like enterprise investment schemes and venture capital trusts. They do this for the very good reason that they want to reduce their various tax liabilities; however, I regard of most of these products as a fund manager’s remuneration package, dressed up as an investment strategy. Whilst they might reduce tax, you can potentially lose more money on the investment itself.
The problem with putting your money into tax planning products like these is that you immediately find yourself invested in products that are not consistent with systematic investing. In other words, they’re not evidence based, informed by decades of empirical academic research and insight. Although higher-risk tax planning products might be suitable for some people, it is important to know that many of these products are poorly diversified, expensive and lack transparency. The success of these products is dependent on speculation and the active manager’s so-called skill. It is also worth noting that these products can be highly illiquid which means access to income or capital is limited and there is a greater possibility of capital loss.
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