Most contractors will earn all of these:
* a salary either 52*the NI Primary Threshold = £5460, or more than that, depending on their accountant's advice and their own feelings
* savings income
* dividend income
The relevant income tax rates (with the just-announced £600 PA increase and £300 Higher Rate decrease) are:
Non-savings income (e.g., employment income):
zero to £6,035: 0%
£6,035 to £41,735: 20%
£41,735+: 40%
Dividend income:
Zero to £41,735: 10% (but the tax is paid by the company in the form of CT)
£41,735+: 32.5% (25% of net dividend, equivalent to roughly 40% of the pre-CT profits of a small company)
Savings income:
Zero to £6,035: 0%
£6,035 to £8,355: 10%
£8,355 to £41,735: 20%
£41,735+: 40%
These totals are cumulative, but the tax is applied in order:
* non-savings income is considered first
* savings income is added on top of that
* dividend income is added last
E.g., £5460 salary, £2000 savings income, £30,000 gross dividends:
#1 Salary: £0-£5460: 0%
#2 Savings income: £5460-£7460 = £575@0%, and £1425 @ 10% = £142.50
#3 Dividends: £7460 to £37460 @ 10% (but already 10% paid)
In taxation terms, your gross statutory income is £37,460, and your personal allowance is £6,035.
The tax due is:
Non-savings: zero
Savings: £142.50
Dividends: £3,000
Total due: £3,142.50
The tax already paid is:
Savings: £400 (deducted at source by the bank on behalf of HMRC)
Dividends: £3,000
Total paid £3,400
Hence, refund due: £257.50
In other words, when you are reading those articles in The Daily Telegraph about higher rate tax on savings, net rates, how wonderful index-linked savings certificates, premium bonds, and other tax-free National Savings products are, you should pretty much ignore them.
Because us contractors don't pay 40% tax. On anything. (Unless we have a few hundred k in savings accounts).
We now have:
£575 a year of savings income, tax-free (this is the £600 PA increase just announced, slightly reduced due to the fact that 52*NI Primary threshold was £25 more than the old PA). At 6% interest (fairly easily achievable), this is ~£10k of savings which you won't be taxed on. 6% net with no investment risk is an excellent return.
On top of that, there is the £2320 taxed @ 10% (the 10% band still exists for savings). At 10% tax, this is 5.4% net.
If you get 6% on your money, then that is £39k of cash that you can hold in a standard savings account and only pay 10% tax. Again, 5.4% is better than some of the complicated and time-consuming schemes pushed on higher-rate tax payers to save money. The 10% rate is relevant to contractors paying themselves less than £8,355.
So from a savings tax perspective, the PA-paying contractor can hold almost £50k in savings accounts and pay very little tax.
Even contractors paying NMW, will only pay 20% tax on their savings, 4.8% net. Not ideal of course, but better than the 3.6% (based on 40% tax) usually posited.
You will of course move £7k/year (plus same for your spouse if you have one) into the shelter of an ISA, but the tax sting for us contractors, on savings at least, is far less painful than for the normal mid-high earner: something that is worth considering:
* when you hear savings products being promoted based on the effective equivalent gross return for a higher rate tax-payer - it's not relevant to you, because you aren't going to pay higher rate tax on your savings.
* when offset mortgages are being sold to you based on 40% tax relief - not relevant to you either, as the extraction of money from your company is largely predicated on the use of dividends, and if your company makes a reasonable of money then you will surely pay 32.5% tax on extraction.
** The only way you can argue for a grossed-up effective savings rate on offset mortgages is if the high mortgage payments force you to take dividends taxable at higher rate: but even then the best case is probably 10% Entrepeneur's relief CGT on winding up, which is an effective retained income of: (1 -22%) -10% = 70.2% against (1 - 22%) - 25% = 58.5%. In other words the offset mortgage can only deliver .585 / .702 relief = 16.66% relief. Even if you make the large assumption that you are going to be offshore/not-working, you still pay the 22% CT, so the absolute BEST case is 78% vs. 58.5% = 25% relief. There will never ever be more than 25% relief on these products, and the real relief is usually a big fat zero.
For me, I am keeping ~£50k (I don't sweat a few extra £k) into my Icesave account, my Ltd. pays into my pension as part of an overall tax-reduction strategy, and the rest of my savings are in other investments in and outside of ISAs (the yielding investments inside the ISA and the Capital Gain-only investments outside the ISA, with the short-term goal of fully utilising mine and my spouse's CGT allowance, and with the first objective of moving the full £14,400 into our two ISAs each year with any surplus cash following on from that).
* a salary either 52*the NI Primary Threshold = £5460, or more than that, depending on their accountant's advice and their own feelings
* savings income
* dividend income
The relevant income tax rates (with the just-announced £600 PA increase and £300 Higher Rate decrease) are:
Non-savings income (e.g., employment income):
zero to £6,035: 0%
£6,035 to £41,735: 20%
£41,735+: 40%
Dividend income:
Zero to £41,735: 10% (but the tax is paid by the company in the form of CT)
£41,735+: 32.5% (25% of net dividend, equivalent to roughly 40% of the pre-CT profits of a small company)
Savings income:
Zero to £6,035: 0%
£6,035 to £8,355: 10%
£8,355 to £41,735: 20%
£41,735+: 40%
These totals are cumulative, but the tax is applied in order:
* non-savings income is considered first
* savings income is added on top of that
* dividend income is added last
E.g., £5460 salary, £2000 savings income, £30,000 gross dividends:
#1 Salary: £0-£5460: 0%
#2 Savings income: £5460-£7460 = £575@0%, and £1425 @ 10% = £142.50
#3 Dividends: £7460 to £37460 @ 10% (but already 10% paid)
In taxation terms, your gross statutory income is £37,460, and your personal allowance is £6,035.
The tax due is:
Non-savings: zero
Savings: £142.50
Dividends: £3,000
Total due: £3,142.50
The tax already paid is:
Savings: £400 (deducted at source by the bank on behalf of HMRC)
Dividends: £3,000
Total paid £3,400
Hence, refund due: £257.50
In other words, when you are reading those articles in The Daily Telegraph about higher rate tax on savings, net rates, how wonderful index-linked savings certificates, premium bonds, and other tax-free National Savings products are, you should pretty much ignore them.
Because us contractors don't pay 40% tax. On anything. (Unless we have a few hundred k in savings accounts).
We now have:
£575 a year of savings income, tax-free (this is the £600 PA increase just announced, slightly reduced due to the fact that 52*NI Primary threshold was £25 more than the old PA). At 6% interest (fairly easily achievable), this is ~£10k of savings which you won't be taxed on. 6% net with no investment risk is an excellent return.
On top of that, there is the £2320 taxed @ 10% (the 10% band still exists for savings). At 10% tax, this is 5.4% net.
If you get 6% on your money, then that is £39k of cash that you can hold in a standard savings account and only pay 10% tax. Again, 5.4% is better than some of the complicated and time-consuming schemes pushed on higher-rate tax payers to save money. The 10% rate is relevant to contractors paying themselves less than £8,355.
So from a savings tax perspective, the PA-paying contractor can hold almost £50k in savings accounts and pay very little tax.
Even contractors paying NMW, will only pay 20% tax on their savings, 4.8% net. Not ideal of course, but better than the 3.6% (based on 40% tax) usually posited.
You will of course move £7k/year (plus same for your spouse if you have one) into the shelter of an ISA, but the tax sting for us contractors, on savings at least, is far less painful than for the normal mid-high earner: something that is worth considering:
* when you hear savings products being promoted based on the effective equivalent gross return for a higher rate tax-payer - it's not relevant to you, because you aren't going to pay higher rate tax on your savings.
* when offset mortgages are being sold to you based on 40% tax relief - not relevant to you either, as the extraction of money from your company is largely predicated on the use of dividends, and if your company makes a reasonable of money then you will surely pay 32.5% tax on extraction.
** The only way you can argue for a grossed-up effective savings rate on offset mortgages is if the high mortgage payments force you to take dividends taxable at higher rate: but even then the best case is probably 10% Entrepeneur's relief CGT on winding up, which is an effective retained income of: (1 -22%) -10% = 70.2% against (1 - 22%) - 25% = 58.5%. In other words the offset mortgage can only deliver .585 / .702 relief = 16.66% relief. Even if you make the large assumption that you are going to be offshore/not-working, you still pay the 22% CT, so the absolute BEST case is 78% vs. 58.5% = 25% relief. There will never ever be more than 25% relief on these products, and the real relief is usually a big fat zero.
For me, I am keeping ~£50k (I don't sweat a few extra £k) into my Icesave account, my Ltd. pays into my pension as part of an overall tax-reduction strategy, and the rest of my savings are in other investments in and outside of ISAs (the yielding investments inside the ISA and the Capital Gain-only investments outside the ISA, with the short-term goal of fully utilising mine and my spouse's CGT allowance, and with the first objective of moving the full £14,400 into our two ISAs each year with any surplus cash following on from that).
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