How to make a tax-free income

Sarah Coles
Updated
Young family with cute little baby boy going over finances at home tax

Despite everything we’ve heard about tax cuts recently, there’s still a good chance you’re forking out more than you were. The threshold at which you start paying income tax — and the level when the rate rises — have been frozen for years now, so any time we get a pay rise, the taxman is rubbing his hands in glee.

At the end of March, we'd paid 5% more tax than a year earlier — with the Treasury pocketing a total of almost £828bn since April last year.

And while we’re all prepared to pay our fair share of tax, at these kinds of levels, it’s no wonder so many of us are trying to think of ways to boost our income without troubling HMRC, and the good news is there are plenty of ways to make tax-free income.

There are some tax breaks that can work in your favour. The first chunk of income is tax-free — up to £12,570 — thanks to your personal allowance.

Read more: Who is the breadwinner in your family and does it matter for your finances?

You also have a personal savings allowance that means basic rate taxpayers can make up to £1,000 in interest from savings each year without paying tax, while higher-rate taxpayers can make up to £500. On top of that, if you earn less than the personal allowance, you also have the starting rate for savings covering the first £5,000 of interest. It means someone earning £12,570 could make £6,000 in savings interest without paying tax on it.

If you’re married or in a civil partnership, and one of you earns less than the other, you might want to think about how you hold things like savings, property or investments.

If your spouse doesn’t earn enough to pay tax, you can switch assets over to them so they can benefit from the tax breaks.

Even if you both pay tax, sharing the assets can cut your tax bill, because it means you can both take advantage of your tax-free allowances. If the lower earner holds the balance, then at least some of the rest may be taxed at a lower rate too.

Don’t forget, if you save using a cash ISA, any interest is tax free, and the same goes for any growth in a stocks and shares ISA or a pension.

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If you invest outside an ISA or pension, you have a £3,000-a-year capital gains tax allowance and a £500 dividend tax allowance. Once you make more than this in profit or income each year, there may be tax to pay.

Looking ahead to retirement, it’s worth bearing in mind that pensions are taxable. However, the income you draw from ISAs, or Lifetime ISAs after the age of 60 is tax-free. Some people will choose to balance how they take an income from all these things to keep their tax bills down.

On top of the well-known tax breaks, there are some lesser-known ones too. The rent-a-room scheme means you can rent a furnished room in your house to a lodger and make £7,500 of rental income without having to complete a tax return or pay any tax.

You also have a £1,000 allowance, which lets you make a bit more tax-free income from your property through things like renting out storage space or a driveway.

If you have a hobby or a side hustle, like babysitting or selling on eBay (EBAY), the trading allowance means you can make up to £1,000 tax free. This hit the headlines earlier this year, when websites had to start reporting your income to the taxman.

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However, the rules remain the same. If you’re just having a clear-out and not selling things for a profit, it’s not taxable. If you’re trading and selling things you bought to profit from, or that you made yourself, you’re a trader, and you can take advantage of this £1,000 allowance. After that, you’ll need to do a tax return and pay tax.

As ever, the rules around tax aren’t a doddle, but there are ways to use them to your advantage and rake in a decent chunk of tax-free income as tax bills continue to mount.

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