From Pensions to ISAs: 10 Overlooked Tax Mistakes That Could Cost You Thousands

Navigating the UK tax maze - ten areas where people can get caught out

This is the third in our trilogy exploring some of the most common pitfalls we encounter in financial planning. Having covered investments and pensions previously, today's focus turns to tax.

The UK tax system is, to put it mildly, bewilderingly complex. What began as relatively straightforward concepts—income tax, capital gains, inheritance tax—has evolved into a web of rules, exemptions, tapers, and thresholds that would challenge even seasoned professionals. Add in the interactions between different taxes, the annual changes in government budgets, and the fact that rules often vary depending on your circumstances, and it's little wonder that even the most conscientious individuals can find themselves inadvertently paying more than necessary.

Below, we've highlighted ten areas where we regularly see thoughtful, diligent clients getting caught out—not through negligence, but simply because the tax system has become so convoluted that these traps are genuinely difficult to spot.

1. Unclaimed Higher Rate Tax Relief

If you're a higher or additional rate taxpayer making personal pension contributions, you're entitled to more than the basic 20% relief that your provider automatically reclaims. But here's the catch—you need to claim the additional relief yourself, either by informing HMRC directly or through self-assessment.

It's a reasonable assumption that all your tax relief would be processed automatically. After all, HMRC knows your income and your pension contributions. Yet the system doesn't work that way. According to previous research by Standard Life (link here), in the five years to 2022, some £1.3 billion of tax relief went unclaimed. 

This particularly affects those earning £50,000–£150,000 who don't typically complete tax returns. They're often unaware they need to take action to claim what's rightfully theirs

The solution? You can voluntarily request to file via self-assessment, where you can include the pension contribution and claim the tax relief due. 

2. Holding Cash ISAs but Taxable Investments

ISAs represent one of the most valuable tax shelters available, protecting both income and growth from taxation indefinitely. Yet we regularly encounter clients holding cash within their ISA allowance whilst keeping investments in taxable accounts.

Given that equities and bonds have historically delivered far superior returns to cash over the long term (of course, past performance is no guarantee of future returns), you're potentially using your most valuable tax shelter for your lowest-returning assets. From a pure tax efficiency standpoint, it usually makes more sense to shelter the assets most likely to generate significant taxable returns—your investments—whilst keeping cash in easily accessible accounts outside the ISA wrapper.

This isn't a hard rule. If you need that cash accessible and secure, keeping it in an ISA makes perfect sense. It's simply worth considering whether you're making the most efficient use of your allowance.

When investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe. Neither simulated nor actual past performance is a reliable indicator of future performance. 

3. The Spouse Transfer Opportunity

Couples are often taxed very differently. If one partner is a high earner and the other has little or no income, transferring taxable assets across can yield significant savings.

Because transfers between spouses are tax neutral (i.e. there’s no tax to pay on the transfer itself, and the recipient receives the assets with the original acquisition cost), it’s often possible to move dividend income into the basic-rate band (8.75% vs 39.35%) and unlock additional CGT allowances—potentially saving thousands each year.

4. ISA Timing

The annual rush to use ISA allowances in March and the beginning of April is entirely predictable—it's when the deadline looms and the financial press reminds everyone about "use it or lose it". Yet this timing works against you.

Every month you delay using your ISA allowance is a month of tax-free growth you've forfeited. This becomes particularly significant with "Bed & ISA" transfers, where you're moving existing investments from taxable accounts into the ISA wrapper.

Execute this at the start of the tax year, and you’ve got a full year of tax-free income and gains. 

5. The £100,000 Trap

The interaction between income tax and various means-tested benefits creates one of the most punitive effective tax rates in the system. Once income exceeds £100,000, your Personal Allowance begins to taper away at £1 for every £2 of additional income. Combined with 40% income tax and 2% National Insurance, this creates an effective marginal rate of 62%.

For parents, the situation becomes even more severe. Free childcare hours and Tax-Free Childcare also disappear around this threshold, creating effective marginal rates that can exceed 100%—meaning an extra £1 of income can cost you more than £1 in lost benefits and additional taxes.

The solution? Pension contributions. Because these reduce “adjusted net income”, you can bring yourself back below the threshold, allowing you to recover your Personal Allowance and childcare benefits whilst building retirement savings..

A pension is a long-term investment and funds are not normally accessible until 55 (rising to 57 from April 2028). When investing via a pension, your capital is at risk. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. 

6. The Childcare Timing Paradox

Adding to the complexity above, entitlement to free childcare hours and tax-free childcare must be declared prospectively, whilst pension relief is claimed retrospectively. Miss this timing mismatch and you can lose thousands in government support, even if you later make pension contributions that bring your income below £100,000.

It's a classic example of how different parts of the tax and benefits system operate on entirely different principles, creating traps for anyone trying to optimise their position.

7. The Hidden Gifting Exemption

Onto inheritance tax (IHT) now and most people are aware of the £3,000 annual gifting allowance for inheritance tax purposes. What's less well known is the "Normal Expenditure Out of Income" exemption, which allows regular gifts out of surplus income to be immediately exempt from IHT—provided they don't affect your standard of living.

This exemption can be extraordinarily valuable, potentially allowing much larger annual gifts than the standard £3,000 allowance. Yet it requires careful documentation and a clear pattern of surplus income—complexities that mean many people miss this opportunity entirely.

The Financial Conduct Authority does not regulate Estate and Inheritance Tax Planning. Inheritance Tax thresholds depend on your individual circumstances and may change in the future.

8. The Pension-IHT Time Bomb

From April 2027, pensions will be included in estates for inheritance tax purposes—a seismic change that transforms pension planning. Yet many people haven't revisited their pension "expression of wishes" forms to consider these new rules (note, this is very much on our agenda for the next round of review meetings with clients).

Who inherits your pension, and at what age, will increasingly determine the total tax liability on those funds. In some cases, beneficiaries could face both inheritance tax on the fund and income tax on withdrawals—a double taxation that careful planning can often mitigate.

This requires thinking about pensions not just as retirement vehicles, but as part of broader inheritance planning—a connection that isn't immediately obvious.

9. The Whole of Life Insurance Misconception

Whole of Life insurance is frequently dismissed as expensive or unnecessary, yet it can be remarkably effective for managing inheritance tax liabilities. 

Rather than thinking of it as "paying insurance premiums in later life", it's often more helpful to view it as a form of wealth transfer - you pay regular premiums during your lifetime, and in return, your beneficiaries receive a tax-free lump-sum on your death, available to settle an outstanding IHT liability, or simply ‘add to the pot’. 

The mathematics can be compelling, particularly for larger estates, yet the complexity of different policy structures and the interaction with trust arrangements means this planning tool is often overlooked.

We’ve written a blog on this previously - click here. 

10. Letting the Tax Tail Wag the Investment Dog

Perhaps most importantly, whilst tax efficiency absolutely matters, it shouldn't drive every investment decision. The temptation to chase tax reliefs can lead to poor investment choices—overly complex products, excessive costs, or concentrated positions that increase risk.

The most effective approach is to be tax-aware rather than tax-driven: build a well-diversified portfolio aligned with your risk tolerance and long-term objectives, then optimise the tax efficiency around those core decisions.

Closing Thoughts

Decades of political tinkering have created a maze that challenges even professionals. What appears as "mistakes" are often perfectly rational responses to an irrational system.

Tax planning isn't about knowing every rule—that's impossible. It's about spotting the opportunities and traps that matter for your specific situation, whilst keeping your overall financial plan focused on achieving your long-term objectives.

Please note, the Financial Conduct Authority does not regulate tax advice. Levels, bases, and reliefs from taxation may be subject to change, and their value depends on the individual circumstances of the investor.

Happy Thursday!

Kind regards,
George

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