Why Using Tax Allowances Matters More Than Ever

Rising living costs create a double financial pressure.

On the one hand, everyday expenses are increasing, which can reduce disposable income and savings. On the other hand, higher costs in retirement mean individuals often need to contribute more towards long-term financial planning.

Using available tax allowances can help offset some of this pressure by ensuring your savings and investments grow in a tax-efficient environment.

Developing a habit of reviewing and using these allowances each year can play a crucial role in maintaining a strong financial plan.

1. ISA Allowance

For the 2025/26 tax year, individuals can contribute up to £20,000 into an Individual Savings Account (ISA).

You can split this allowance between:

Cash ISAs

Stocks and shares ISAs

Or a combination of both

One important feature of the ISA allowance is that it cannot be carried forward. If you do not use it before the end of the tax year, it is lost.

ISAs remain one of the most valuable tax wrappers available because:

Interest earned is tax-free

Investment growth is tax-free

Withdrawals are tax-free

Cash ISAs may suit individuals who require short-term access to savings, while stocks and shares ISAs offer long-term growth potential through investment in markets.

Although funds can be withdrawn at any time, staying invested over the longer term can help smooth market volatility.

2. Pension Contributions

Pensions remain one of the most tax-efficient ways to save for retirement.

Contributions benefit from tax relief at your highest marginal rate, which can significantly reduce the effective cost of saving.

For the 2025/26 tax year, the standard pension annual allowance is £60,000. This includes contributions from:

you personally

your employer

third parties

Personal contributions are limited to 100% of your earnings, or £3,600 if higher, and tax relief is normally applied automatically at the basic rate.

Higher or additional rate taxpayers may be able to claim additional relief through their tax return.

For individuals earning over £200,000, the annual allowance may be tapered, potentially reducing it to as low as £10,000. However, unused allowances can often be carried forward for up to three years.

Another key benefit is that investment growth within pensions is free from capital gains tax and income tax.

It is worth noting that from April 2027 most pension funds will form part of an individual’s estate for inheritance tax purposes, adding a new layer of complexity to retirement and estate planning.

3. Capital Gains Tax Allowance

Capital gains tax (CGT) may apply when you sell assets such as:

shares held outside an ISA or pension

second properties

art or valuable collectibles

Each individual has an annual capital gains tax allowance, known as the Annual Exempt Amount.

For the 2025/26 tax year, this stands at:

£3,000 for individuals

£1,500 for most trusts

Spouses and civil partners can combine their allowances, creating a £6,000 tax-free buffer for jointly owned assets.

If you are planning to sell investments or other assets, it may be possible to spread disposals across multiple tax years in order to utilise multiple allowances.

CGT rates depend on your income tax band:

18% for basic rate taxpayers

24% for higher and additional rate taxpayers

Because capital gains planning can become complex, professional advice can help identify the most tax-efficient approach.

4. Dividend Allowance

If you hold shares outside an ISA or pension, you may receive dividend income.

For the 2025/26 tax year, the first £500 of dividend income is tax-free under the dividend allowance.

Any dividend income above this allowance is taxed according to your income tax band:

8.75% for basic rate taxpayers

33.75% for higher rate taxpayers

39.35% for additional rate taxpayers

Dividend tax rates are expected to increase in the 2026/27 tax year, rising to:

10.75% for basic rate taxpayers

35.75% for higher rate taxpayers

Given these changes, holding investments within ISAs or pension wrappers can offer a more tax-efficient solution where appropriate.

5. Inheritance Tax Gifting Allowance

The UK inheritance tax system includes several gifting allowances that allow you to transfer wealth without increasing the value of your taxable estate.

The main annual gifting allowance is £3,000 per person.

If unused, this allowance can be carried forward for one tax year, meaning a couple could potentially gift £12,000 between them.

Additional exemptions include:

£5,000 for a child’s wedding gift

£2,500 for a grandchild’s wedding gift

£250 small gifts to multiple individuals

If gifts exceed the allowance and you die within seven years, the excess may be included in your estate for inheritance tax purposes.

Gifting strategies can be a powerful tool in long-term estate planning, helping to gradually reduce the size of a taxable estate while supporting family members.

Taking a Holistic Approach to Tax Planning

While each of these allowances may appear modest in isolation, together they can form a powerful strategy when used consistently.

Taking a holistic approach to financial planning means reviewing your pensions, investments, savings and estate planning together to ensure your wealth is structured as efficiently as possible.

With tax thresholds frozen and the cost of living remaining elevated, making full use of your allowances each year can help protect your long-term financial security.

Professional advice can help identify which allowances are most valuable for your individual circumstances and ensure they are used effectively.

Disclaimer

This article is for general information purposes only and does not constitute financial advice. Tax rules depend on individual circumstances and may change in the future. Professional advice should always be sought before making financial decisions.

Capital at risk. Investments may fall as well as rise in value and you may not get back the amount originally invested.