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How to Earn £34,000 Tax Free

This weeks budget brought about some big controversial changes. I won’t delve into all of them here, but instead comment on the fact that this and other recent budgets have made it possible to earn significant amounts of income without paying any tax – something most people are interested in!

I’m lucky in a sense that I currently earn a good London based salary in the financial services industry – well above the UK average. This also means that every month I pay a sizeable chunk of my salary away in income tax. Unfortunately I’m not a fat cat (more of a little kitten) so the firm won’t pay me in some highly efficient offshore/deferred/sharebased/tax minimizing manner. I get paid well but at the end of the day I’m a plain old PAYE monkey.

While I’m happy to pay my share of taxes the current regime is certainly not one that promotes fairness. The chart below is a little out of date but take a look at how the marginal rate of tax paid changes as your earnings increase:

UK Marginal Tax Rates


I’m sure most people would agree that the more you earn the more tax you should pay. However I’m sure most people would also agree that it’s a bit unfair that someone increasing their earnings over one of the current thresholds suddenly sees their marginal tax rate doubling. What possible/logical reason is there for the marginal rate to spike up at £100k only to drop back down at £115k?

Answer: None.

Surely a much fairer way would be to design a system where the blue line is a steady/predictable upward diagonal slope, devoid of the large steps we currently have.

If you were to ask a million monkeys to sit down and design a tax regime for the UK from scratch, I would wager everything I own that none of them would come up with anything remotely similar to what we currently have in place. The same would almost certainly hold true if you left the monkeys to their bananas and instead asked a million civil servants.

The effect that this system has had on me personally is de-motivation. To work harder, put in more hours, grease more poles, polish more turds is rewarded with not much extra post tax income. Unless there is the carrot of a BIG pay rise then I’m afraid the system motivates me to tread water, do just enough and frankly add to Britain’s appalling productivity rates.

There’s no need for violins because I know I’m incredibly lucky to earn what I earn. I may already be over paid and/or just plain lazy but the system currently de-motivates me

What does motivate me is to fully utilize any tax free allowances that are kindly made available to my wife and I by the government. I’ve discussed some of these allowances before on the site but the recent budget brought about some changes that are worth mentioning.

Dividend Tax Changes

One  key announcement in the budget was that existing dividend tax credits will be replaced by a new £5,000 tax free dividend allowance for all tax payers starting form April 2016. Go above the £5,000 and your dividends will be taxed at the following rates:

  • Basic rate taxpayers: 7.5% (up from 0%)
  • Higher rate taxpayers: 32.5% (up from 25%)
  • Additional rate taxpayers: 38.1% (up from 30.56%)

The dividend tax credit scheme currently in place is arcane and unnecessarily complex so a simplification such as this is surely a good thing and long over due.

By making these changes the government is giving a benefit to those with lower level dividend incomes and increasing the taxes for those with sizeable portfolios that throw off lots of income.

In fact the real reason for this change is that by upping the tax rates on dividend income the government is trying to discourage ‘Tax Motivated Incorporation’ or TMI (setting yourself up as a limited company and paying yourself dividends rather than salary in order to save tax). As a result many of the contractors I work alongside are cursing big George as their tax bills will be on the increase from April next year.

To date most of my stock market investments have been sheltered away in ISAs, something that’s been made more possible when the annual limits were raised to £15,000. From a personal perspective I’m viewing this £5k dividend allowance to be like an additional floating £100k(ish) ISA allowance attached to my previously taxable trading account. In other words I can build up a portfolio outside my ISA that can throw off up to £5k a year of tax free income.

Personal Allowance Increased

The personal tax allowance is to be raised from £10,600 to £11,000 in April 2016. Not spectacular but it means that the first £11,000 you earn isn’t taxed.

So what about that £34k?

So taking a step back, what does all this mean? Well in effect you can  now pull in an income of £17,000 per year without paying a single penny in tax. To do this you’d need to have:

  • A salary of £11,000
  • A share portfolio producing £5,000 in dividend income
  • Cash savings yielding £1,000 in interest

If both you and your partner tick all of the above boxes then you can generate £34,000 tax free income per year. If you’re living a frugal life, keeping your expenses low , manage to pay off the mortgage early then you should be able to scrape by on £2,833 each month!

Of course this is before you take in to account the very generous ISA allowances on offer (currently £15,240 per year). All income produced by ISAs is tax free too and there is (currently) no limit on it.

Given my current marginal tax rate I’m certainly aiming to get my wife and I in a position to be able to maximize as many of these allowances as we approach financial independence.

{ 20 comments… add one }
  • Dan July 9, 2015, 6:23 pm

    Great article. Please don’t forget about NI contributions though: the NI personal allowance is not 10600, but much lower unfortunately.

    • Under The Money Tree July 10, 2015, 8:24 am

      Correct, you’ll still need to pay NI on income between £8,060 and £42,380 per month at a rate of 12% 🙁

  • MyRichFuture July 9, 2015, 9:33 pm

    The main worry I have about keeping a large dividend-paying portfolio outside of an ISA (roughly £125k to generate £5k at 4% yield) is the Captial Gains Tax headache. But it is an option if you come into a windfall.

    • Under The Money Tree July 10, 2015, 8:27 am

      Correct you need to keep an eye on your capital gains. However that shouldn’t be a problem as when/if you’re approaching the capital gains allowance you can sell and swap into new securities in order to ‘reset’ your gains. This is particularly easy if you’re indexing. Not ideal and you’ll end up losing some $ to fees but if it means you’re taking the income tax free then it’s probably worth it.

  • BeatTheSeasons July 10, 2015, 10:03 am

    My main issue with this budget is that it protects those who’ve already accumulated capital at the expense of those trying to make it there.

    Taking away higher rate tax relief on pension contributions will be the single biggest barrier to saving. Raising taxes for contractors and targeting BTL landlords are also ways of taking money away from those who are trying to build some wealth for the future. Whether or not you agree with the specific taxes, the point is that the Chancellor is targeting income, while leaving generous tax reliefs like unlimited ISA balances completely untouched.

    I’m not going to get involved in the debate about the ideology behind cutting benefits in general, but increasing the tax burden for poorer working families while leaving non means tested benefits for pensioners intact seems perverse. I’m talking about free bus travel for millionaires and winter fuel allowances for people who fly to their villa in Spain for the colder months.

    I have a colleague who is 21 years old and spends over 100% of her income on the latest iphones, cars on HP, foreign holidays, etc. She’s saving nothing for the future but she doesn’t have to; she’s an only child and stands to inherit her parents’ expensive house tax free. Like you, I find it quite demotivating that I would need to earn £1.72m to accumulate the same pot of capital that she will get without any work at all. It can’t be right that the lowest rate in the whole tax system applies to those who do the least.

    • Under The Money Tree July 10, 2015, 11:45 am

      While the dividend tax changes are clearly targeting contractors personally I see that this is only fair. In my world I know of lots of people that switched to contracting purely for the lower taxes and have made a lot of money from it. Of course these changes will discourage small business ownership to some degree but the dividend tax rates above the new threshold are lower than income tax rates still so there is still some ‘risk’ premium being given to contractors/business owners.

      As for the BTL changes I’ll likely cover those in a separate article soon….i’ll just say that they look like bad news for me personally 🙁

      IHT – This is a tricky one. I know of lots of different people in different circumstances that would be affected differently by IHT and these changes. While I agree in principle that you should be allowed to pass more onto your children, however it does create a system where the wealth doesn’t get redistributed. I’m not really sure what a fair answer would/should look like.

      • Monevator July 10, 2015, 11:15 pm

        Regarding dividend tax rates versus income tax rates, remember that companies have to pay corporation tax on profits *before* any of it can go out as dividends. For the sort of small companies you’re talking about, company profits and potential earnings are essentially the same thing.

        • Under The Money Tree July 12, 2015, 6:08 pm

          True, an additional 20% corporation tax (or 19% as George announced) added to the current dividend tax gets you up near income tax rates I suppose. However am I right in thinking there’s no NI to pay if you’ve set yourself up as a LTD company?

          • London Rob August 20, 2015, 4:05 pm

            Hi UTMT,

            You are right – if you pay yourself a low enough wage then you dont pay any NI (I’m not a contractor btw). I have a lot of friends who are complaining about this, but who have done VERY well by avoiding the tax that I have to pay that keeps them on the NHS etc. I also dont think they have realised that by not paying the NI they are not building up any entitlement to a state pension, so that is going to be a shocker for them at the end when it is too late to do anything.

            I personally would like to see a much simpler tax system – same rate across the board (on types of income) to help avoid this – reduce the complexity, less public sector to look after it, less tax needs to be raised etc.
            I appreciate that the BTL tax changes will impact you personally, but I actually support this – it should not be cheaper and easier to purchase a residence as an investment than for somewhere to live. It doesnt affect me as I dont have a BTL, but we do have our own property (but with a mortgage), and nearly ended up BTL on my old flat!

          • Under The Money Tree August 25, 2015, 5:23 pm

            London Rob,
            Contrary to what you might think I’m not averse to the BTL tax changes. As mentioned previously on this site my BTL strategy has always been focused on low leverage and capital repayment. Long term I aim to have them debt free so I’ll just stay calm and maintain my current approach of deleveraging as much as possible.

  • Dividend Drive July 10, 2015, 11:44 am

    Great post UTMT. I had not thought of the £5,000 dividend income allowance as being an additional ISA-esque allowance. Quite a nice way of looking at it, I think.

    At the moment, 90% of my investments are in an ISA which is–obviously–great news. If I don’t quite invest the full ISA allowance this year with fresh funds I am looking to shift over the other 10% of my investments before the end of the tax year.

    You’re right about the tax regime. Even if they only doubled the number of tax grades it would be a vast improvement without making it overly complicated for either the taxpayer or the state. I strongly suspect it will not occur, however!

  • UK Value Investor July 10, 2015, 1:07 pm

    Hi UTMT, I guess like most people I tend to squirrel any savings away into an ISA or SIPP so I don’t have to think about things like dividend tax rates.

    As for the dividend change being about contractors, is it? I thought that’s what IR35 was supposed to get rid off, although I think that was limited to contractors who work for a sole client over a long period of time, i.e. they’re little different than employees.

    Anyway, it’s good to know that the increasing tax free zone means a dividend income can be topped up with a little bit of work and that it won’t immediately be hammered with tax.


  • ermine July 10, 2015, 1:58 pm

    > Unless there is the carrot of a BIG pay rise then I’m afraid the system motivates me to tread water, do just enough and frankly add to Britain’s appalling productivity rates.

    Pah, just you wait until you reach FI, in which case you will become a total utter deadweight loss to The System 😉 The whole point of financial independence is to be able to become totally unproductive without stiffing your lifestyle.

    I’m with MyRichFuture – CGT is the hazard on a big unwrapped holding. I’m still in fear of a corporate action on one of my unwrapped holdings and am trying to switch a bit out of that every year. Corporate actions aren’t something you can plan for or stall into another TY and could force you to crystallise a capital gain in one lump. It even happens with index funds and ETFs. Plus you have the regulatory hazard of changes to the CGT regime and to the amount of tax-free dividend income allowed. It’s not like these haven’t been fiddled with in the past!

    • Under The Money Tree July 13, 2015, 8:54 am

      True, CGT can be an issue….I like to call this type of thing a ‘good problem’. That ETF graveyard link is fascinating. I can’t believe there was such a thing as a Solid State Drive index/etf!

  • SparkleBee July 11, 2015, 4:38 pm

    Hi UTMT,

    I have a large share holding outside an ISA wrapper. Due to an ex-employer share scheme, it has been providing a great income stream which in total with my other non-ISA shares has earned more than £5k pa in the last 2 years. I now need to look at using the CGT allowance and sell and move it across into possibly less generous ISA funds so that the dividends come in under the threshold – rebalancing in action 🙂 . I will need to wait until next TY before I can open a new ISA and put some of this money into a tax-free wrapper.

    I too have a BTL and still need to work out what this change means to me as I have a mortgage on the property – I cannot redeem this without paying penalties and also tying up money into the property – reducing my liquidity. Sounds great for landlords who own their properties outright., it is being phased in so its a matter of finding out what this means.

    It will encourage some landlords to sell property which will:
    – increase house sales
    – possibly bring prices down due to a glut of properties on the market
    – increase CGT income to the government as landlords cash in profits
    All a short-term ‘good news’ element for the government & media to report on – while waiting for all those new houses to be built.

  • Neverland July 13, 2015, 2:44 pm

    I actually think you can take more than £74,000 income tax free per year out of the system in retirement right now

    The example assumes a 5 year retirement (for simiplicity) and a couple with two £1m SIPPs plus separate unwrapped investments

    – £11,000 income tax limit from each SIPP (this is about a 1.5% withdrawal rate so your capital is unlikely to be depleted)
    – £10,000 a year tax free lump sum out of the SIPPs for 25 years
    – £1,000 interest allowance
    – £5,000 dividend allowance
    – £10,000 capital gains tax exemption from selling unwrapped investment

    x2 = £74,000

    Then on top of that you pay no income tax on whatever ISAs or VCTs you have got

    Did I mention the winter fuel allowance?

  • Mr Zombie July 14, 2015, 8:16 am

    “To work harder, put in more hours, grease more poles, polish more turds” – an apt description of most office work 🙂

    £34k would be a grand old amount to live off, completely tax free.

    To me this does highlight, once again, how quickly the tax regime can change and so how quickly prospective strategies can change. Remaining flexible and diversified really is key.

    I do wonder if they are eyeing up larger pension pots and ISA’s for some ninja like tax attack…

    I did think they would start to close the doors for contractors, who have been making a killing for years employing themselves through their own company. They will still be making a fair old wedge, so I don’t feel to bad for them! And it still remains a relatively attractive option to me, especially in the last couple of years of saving when the risk of contract not being renewed means less…

    Mr Z

  • theFIREstarter July 29, 2015, 8:52 am

    Genius! I think we could easily get by on nearly £3K per month when mortgage free. Hell… we’d be living like kings no less!

    And people have the audacity to complain about taxes eh… 😉

  • Andy August 15, 2015, 1:47 am

    Don’t forget the capital gains tax allowance and the rent a room scheme.

  • Colin February 2, 2017, 10:54 pm

    £11k in income is not subject to NI if it’s pension income………..so it’s correct that if you have pension income of £11k then its possible to earn £17k tax free.

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