With taxes at their highest level since World War II, it’s never been more important to stay on top of the rules.
A little bit of extra work can go a long way, helping you to avoid a big surprise tax bill from HMRC and continue to build your wealth.
Let’s take a look at five common tax traps and how to avoid them in 2025 👇
If you’re a higher or additional rate taxpayer, you’re entitled to 40% or 45% relief, respectively, on pension contributions. But, most pension providers won’t automatically process the full amount of relief you’re owed.
They’ll only process the 20% relief basic taxpayers are entitled to. This means that if you’re a higher and additional rate taxpayer, you need to claim the extra relief you’re entitled to through your tax return or direct with HMRC.
Let’s say you’re a higher rate taxpayer. If you pay £800 into a SIPP your provider will automatically claim £200 tax relief on your behalf. After filing your tax return with details of your pension contributions HMRC will pay you a £200 tax rebate. After the relief is claimed, the £1,000 pension contribution effectively costs you just £600 after tax.
While pension tax relief is an easy way to increase the value of pension contributions, the reality is that many people don’t consider whether they need to file a tax return and may simply forget to claim this money they’re owed.
If you think this tax trap might affect you, then you can write to HMRC setting out details of your pension contributions. You may also be able to claim tax rebates from up to 4 previous tax years if you realise you forgot to claim.
If you’re a high earner and expect a pay rise next year, you could be in for a nasty tax shock in 2025.
The problem is that there’s a hidden 62% tax trap waiting for those who are lucky enough to earn over £100,000.
The punishing tax rate is triggered because high earners start to lose their £12,570 tax-free personal allowance once they earn over £100,000. For every £2 earned over £100,000, £1 of the allowance is lost, disappearing entirely once you earn over £125,140.
This vanishing personal allowance comes on top of paying 42% tax, made up of 40% income tax and 2% national insurance. It means high earners pay an eye-watering 62% tax on income between £100,000 and £125,140.
Although a salary of £100,000 may seem high, frozen tax thresholds are pulling more people into this tax trap each year. In the past 12 months 537,000 taxpayers were hit with 62% tax, a significant rise from 436,000 the previous year.
So is there anything you can do if you find yourself caught in the 62% tax trap?
The good news is that it's possible to substantially reduce your tax bill by increasing your pension contributions. While this means reducing your take home pay today, you’ll get a boost to your long-term savings at a low cost.
If you’re in this income bracket, then it will cost just £400 to pay £1,000 into your pension. As long as you remember to claim your additional tax rebate!
With Christmas just weeks away, you might be tempted to avoid the busy shopping malls and instead give a financial gift to your loved ones.
Unlike cash gifts, many people don't realise that gifting financial assets, like shares or property, could trigger a tax bill. Under tax rules, these gifts are treated like selling assets, which could lead to a capital gains tax liability.
With capital gains tax rates rising after Labour’s inaugural budget, you could end up with a painful tax bill if you give away assets that have significantly gained in value.
Understanding this tax trap is particularly important if you live with an unmarried partner. But unlike spouses, unmarried partners don’t have a tax exemption for capital gains tax.
For example, if an unmarried partner gives a rental property to their partner which has gained in value by £200,000, they could owe tax of up to £47,280, depending on their tax rate.
Making financial gifts, including cash, also has implications for inheritance tax so it’s important to seek tax advice if you’re planning to give away assets.
Paying into a pension is a great way to boost your wealth, allowing you to contribute up to £60,000 each year while shielding your investments from future tax.
However, there’s a little-known tax trap where it’s possible to almost completely lose your £60,000 annual pension allowance and see it slashed to just £10,000 each year.
This happens when you start to take out taxable income from a pension pot, in the form of either a taxable lump sum or drawdown. When you start making taxable withdrawals this could reduce the amount you can save into your pension to £10,000. This is known as the money purchase annual allowance.
If you're planning to take a 25% tax-free lump sum from your pension, don't worry. Your annual allowance is only affected if you take out taxable income. Despite budget rumours, you can still take 25% of your pension tax-free from when you turn 55, rising to 57 in 2028.
If you’re planning to start withdrawing pension wealth then it’s important to do your research or take financial advice as the rules are complex.
Experienced investors already know that ISAs and pensions are great tools for cutting tax. And with capital gains tax increasing, making the most of tax-free investments has never been more important.
Thanks to the budget, capital gains tax rates on shares have increased from 10% to 18% for basic-rate taxpayers and from 20% to 24% for higher-rate taxpayers, landing investors with bigger tax bills than ever before.
However, despite rising capital gains tax bills, many investors still pay unnecessary tax because they’re investing outside a tax wrapper.
You can invest up to £20,000 tax-free inside an ISA each year and up to £60,000 in a pension and completely protect your investments from capital gains tax. You’ll also shield any dividend income from UK dividend tax.
When it comes to your ISA allowance, it’s use it or lose it. You can’t carry forward unused allowance from previous tax years.
Unused pension allowances, on the other hand, can be carried forward up to 3 years. Though your annual pension contributions remain capped at the amount you earn in that particular tax year.
Using your ISA or pension to avoid tax might be one of the simplest tax hacks, but it’s also one of the best. With the tax burden continuing to rise, protecting your wealth from unnecessary tax is a great way to continue building your long-term wealth in 2025.
Since it’s now more important than ever to make the most of your annual ISA and pension allowances, maybe it’s a good time to consider moving your accounts to Freetrade?
Right now, you can get up to £2,000 cashback if you transfer an ISA to Freetrade.
But that’s not all. You can also get up to a further £2,000 cashback when you transfer a pension to Freetrade.
For both offers, transfer at least £10,000 to qualify. Cashback capped at £2,000. Annual subscription required. Terms apply. Offer ends 31 December 2024.
