How to Save Efficiently (Run Away from Tax Man Successfully) in United Kingdom?

Benjamin Franklin once said that ''In this world, nothing is certain but death and taxes.''

I've been working in London for more than 6 years now and I have been properly acquainted with the endless taxes that I need to pay every month. The harder you work, the more taxes you pay. This type of income is called a ''realized income''. It is the income you have earned and received. Before it gets credited into your bank account, the tax man have already taken his share of your hard-earned money! It is the most sad thing in this world similar to being broken hearted.

On the other hand, there is what we call a ''unrealized income''. It refers to profits and losses on paper. For example, a stock you have held for years increased in value overtime and that gain is your unrealized income. It only becomes realized when you sell it. If you put it this way, the more unrealized income you will accumulate in life, you are gaining profit without being taxed (yet)! This is how you trick the tax man.

Let's say you purchase one share in Tesla at $50 per share (How I wish this is the real cost for it!) and then afterwards the share's price soars to $100. However, you decide to hold onto it because why not? Mr. Elon Musk is bringing us to Mars! Nobody should bet against somebody who will bring us to Mars. You now have an unrealized income of $50. In general, capital gains are taxed when they become realized. It goes the same way with capital losses.

A home is another good example of unrealized income. You purchased a house for $100,000 (let's assume that mortgage have been fully paid off). Now, it is worth $200,000. The unrealized income is $100,000 and since you haven't sold it yet, then there are no taxes for it.

Image A: The Millionaire Next Door excerpt

I read a book titled ''The Millionaire Next Door'' by T. Stanley and W. Danko. The book was about a comprehensive research on ''Who the wealthy are in America and how they got that way?''. It interviewed five hundred millionaires and eleven thousand high-net worth respondents. It asked each respondent about his or her attitudes and behaviors regarding a wide variety of wealth-related issues. On Image A above, it says that only 6.7% (just imagine!) of the millionaire's wealth is subjected to some form of income tax. They know that the more they realize, the more they must allocate for income taxes! Hence, the important rule is:

To build wealth, minimize your realize (taxable) income and maximize your unrealized income

So how do we apply this concept to our lives?

We need to take the maximum advantage of tax-deferred and tax-sheltered investment vehicles to be able to save efficiently.

First, I highly recommend the pension plans set up by employers. If you can avail for the maximum contribution then go for it because your employer will try to match it. It is FREE MONEY! Currently, I am working as a temporary staff and the company I am working for enrolled me to a pension plan where in I contribute 5% of my weekly salary while they match it with a 3% contribution. It is not bad because I am already setting aside 8% of my income which is already a good progress if we follow the 50-30-20 budget rule where in 20% of your income is allocated to savings and investments. On top of this, the pension plan has tax relief benefit (which I have in my current pension plan).

Next, avail for tax-sheltered Income Savings Accounts (or popularly known as ISAs). There are different types but I would focus on these three:

• Cash ISAs - This is where you can place your cash while earning a fixed interest rate for the tax year. The interest rate depends on the institutions / banks offering it. NatWest offers a fixed rate (0.15%) annually for Cash ISAs.

• Stocks and Shares ISAs - This is used to buy stocks and shares and avail for Dividend Tax and Capital Gains Tax allowances!

The tax-free dividend tax allowance will remain at £2,000 for the 2020/21 tax year.

The tax-free capital gains allowance is up to £12,300 before you start paying for it for the 2020/21 tax year.

• Lifetime ISAs - This is used to buy your first home or save for later in life. You are able to put in £4,000 each year (until you become 50 years old). The government will add a 25% bonus to your savings (up to a maximum of £1,000 per year).

For all of these Income Savings Accounts (ISAs), you can only have a maximum of £20,000 savings where all your earnings will be completely tax free. This is limited to Cash ISA and Stocks / Shares ISA as examples. You can spread the allowance according to your goals.

On top of this, a new personal savings allowance was introduced in 2016 where in a basic rate tax payer can earn £1,000 from savings before they start paying income tax. For high-rate tax payers, they can earn £500 without being taxed. This will remain for the 2020/21 tax year.

Lastly, it is a good idea to avail of SIPP which means Self-Invested Personal Pension on top of your company's pension scheme. This works in a similar way to a standard personal pension but it is a Do It Yourself (DIY) kind. A SIPP receives full income tax relief. Yes, you hear that right. Any money you invest in your SIPP will be topped up by 20% by the taxman, and higher or additional-rate taxpayers can claim back a further 20% or 25% respectively. Basically, this means that:

• Basic Rate (20%) Taxpayer contributes £80 and saves £100.

• Higher Rate (40%) Taxpayer contributes £60 and saves £100.

For this tax year 2020/21, most people are allowed to pay up to £40,000 into their SIPP. This means that a £32,000 contribution will give you a £8,000 worth of tax relief.

My thoughts on this...

I am still working towards my Emergency fund while working towards maxing out my ISAs and SIPP account. Honestly, it takes discipline to be able to focus and stick with the budget. However, it is also important to be able to balance things by enjoying life because life is short. It will always boil down to what you want to achieve in life. I really want to achieve Financial Freedom because it will give me options and more time to do the things I am passionate about. It is not about material things. I am not really interested in that.

Started reading about Tao Te Ching and I want to live my life in accordance to the Way of the Tao... I just want to live my life as spontaneous as I want it to be!

''Universes are born and die. Stars are formed from dust, blazing brightly, providing light and life to all living beings, all of whom flicker on and off throughout eternity like fireflies. The dance of creation — of birth, expansion, decay, and death — happens quite by itself, like a vast cosmic program playing itself out across eternity — and it all happens with absolute effortlessness!

Life simply lives itself.''

I hope you learn something from this post! Happy investing...