Monday, 14 March 2016
Most taxpayers in the UK have a personal income tax allowance, which means that on the first £10,600 of your income (£11,000 from April 2016) you pay no income tax. However, if you earn more than £100,000 you start to lose this personal allowance.
For every £2 of income you earn above £100,000 you lose £1 of your tax-free personal allowance. This means that by the time you earn £121,200 (£122,000 from April 2016) you have lost the whole allowance.
The effect of this is that more of your income is taxed at the higher rate of 40%. As such, for every £1 you earn above £100,000 you pay 60p in tax and 2p in national insurance – a total tax rate of 62%. This is even higher than the 45% rate that kicks in above earnings of £150,000.
As the Financial Times recently pointed out, that is the highest tax rate in Europe.
The Government doesn’t recognise the existence of a 60% tax band (62% including national insurance), but it is real, and is affecting more and more people each year. HMRC projections suggest that more than 1m people could be earning more than £100,000 by 2018-19.
If you find yourself in this situation, the only way to avoid this punitive tax rate is to reduce your effective earnings. That might sound drastic, but it doesn’t involve giving up your job. You can achieve this by making a contribution to your pension fund.
For example, someone earning £101,000 who puts £1,000 of their gross salary into a pension will save income tax of £400, while also clawing back £500 of their personal allowance (worth another £200 in saved tax). And they will cut £20 from their national insurance bill.
That’s a total tax saving of £620, and the worker will have boosted their pension savings by £1,000.
Even better, your employer will have saved £138 in national insurance as well, and they might offer to put some of this into your pension.
If you are feeling generous, gifting £1,000 to a charity has the same effect as making a pension contribution – you still save £620 in tax, meaning the net cost of your donation is only £380. If you have a favourite cause, it’s a great opportunity to give to it. And, unlike pension contributions, charitable gifts can be backdated to the previous tax year if needed.
So, if you find yourself with earnings (including bonuses etc.) of above £100,000, get some advice about the potentially huge tax savings that pension saving and charitable giving offer. Get in touch for more information and a free initial consultation.
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