How to enjoy a tax-free income

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There are several approaches offer an annual tax-free allowance you can take advantage of each year. Photo: getty (erdikocak via Getty Images)

Stealth taxes mean the taxman is pocketing fistfuls of our money whenever we take an income.

In the nine months to January, we paid £312.6bn in income tax and national insurance — up 13% in a year.

To make matters worse, from April, the lower additional rate tax threshold and dividend tax allowance will mean some people are handing over even more of their money.

The personal allowance and the higher rate threshold have been frozen since April last year, and the additional rate tax threshold falls in April from £150,000 to £125,140.

The dividend tax allowance will also halve to £1,000.

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So it’s well worth exploring the options for tax-free income. Sharing assets with your spouse, making money from your hobbies and even using a clever technique to pay care home fees can help you avoid paying over the odds and keep more of your hard-earned cash.

Many of these approaches offer an annual allowance you can take advantage of each year, so it’s worth getting to grips with what’s on offer before you lose this year’s allowance for good.


The first £12,570 of taxable income per person per year is tax-free. The personal allowance is the amount you can earn before you start paying income tax. It is reduced by £1 for every £2 of taxable income above £100,000.

If you rent a furnished room of your home to a lodger, the first £7,500 of rent each year is tax-free.

If you have a hobby side business, like babysitting or selling on eBay, the trading allowance means you can also make up to £1,000 tax free.

You can also make another £1,000 from your property tax free by renting out storage space or a driveway.

Young family at home
It’s worth getting to grips with what’s on offer before you lose this year’s allowance for good. Photo: Getty (Klaus Vedfelt via Getty Images)


The personal savings allowance means the first chunk of interest may be tax free. Basic rate taxpayers can receive up to £1,000 in interest from savings accounts each year without paying tax, while higher-rate taxpayers can receive up to £500. Additional rate taxpayers, however, don’t have this allowance.

If you earn less than the personal allowance from wages and pensions, you also have the starting rate for savings — so the first £5,000 of interest on your savings is tax-free.

You get the personal savings allowance on top of that. It means you can make £12,570 from wages, and £6,000 in savings interest without paying any tax.

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However, for every £1 of non-savings income over your personal allowance, you lose £1 of your starting savings allowance, so if you earn £17,570 you lose all the allowance.

Interest from cash ISAs is also tax-free. Savers can stash up to £20,000 in a cash ISA in the current tax year.

Premium Bond prizes are tax-free so whether you win £25 or £1m, you won't have to pay any tax on it.


Income from stocks and shares ISAs is tax-free. You can take bond income or dividend income free of tax — or cash in your investment and take it out without paying capital gains tax. This can be a useful way of boosting your income without having to worry about going over a tax threshold.

Any money withdrawn from a lifetime ISA is tax-free. If you’re using it to buy your first property, the cash will go straight into your new home. But if you leave the money for use in later life, you can use it to create a tax-free income from age 60.

If you have investments outside an ISA, the first £2,000 of dividend income is free of tax in the current tax year. Unfortunately, this will fall to £1,000 in April and £500 a year later.

Read more: Tax hikes: Why it's time to rethink the way you save and invest

Venture capital trust (VCT) investors get tax-free income — plus 30% tax relief.

VCTs invest in companies that are typically small, unlisted and high risk. If you’re an experienced investor prepared to take high risks, VCTs offer substantial tax perks. Any income paid out is tax-free, and income tax relief is also available, up to a maximum of 30% of the amount invested (capped at £200,000 per tax year). VCTs are also capital gains tax free.

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Couples can share assets to double their tax-free allowances. Photo: Getty (kkshepel via Getty Images)

Tax planning

If you’re married or in a civil partnership, you can share assets between you and double the amount of money you can make before the taxman takes a slice.

For example, you can share income-producing assets with your spouse, so you can both take advantage of your personal allowance, dividend allowance and ISA allowance.

Insurance income

The income paid from a private income protection insurance policy is tax-free. This insurance is designed to replace part of your earnings should you be unable to work long-term.

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Long-term care annuities also pay a tax-free income. One of the most tax-efficient ways to help pay for long-term care is to use a long-term care annuity, also known as an immediate needs annuity. The income is tax-free if paid direct to the care provider.

Purchased life annuities can generate a tax-free income too. These are designed to provide a guaranteed income for life or over a fixed term, in exchange for a lump sum.

Part of the income paid is deemed to be a return of your original investment and therefore is tax-free. The interest element of the income is taxable, but no tax will have to be paid if it falls within the personal allowance or personal savings allowance.

Watch: How to save money on a low income

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