Income tax savings for high earners
4th October, 2022
Following up on our ‘What Happens when your salary goes over £100k’ blog, it is perhaps time to discuss a few methods by which you can prevent losing your allowances, avoid paying an effective tax rate of 60% on income falling between £100,000 and £125,140, and/or reduce your tax liability. Here are a few suggestions for higher- and additional rate taxpayers:
Saving money for retirement may be the last thing on some individual’s minds, especially those in their 20s, 30s, or even 40s. Locking money into a pot that isn’t accessible until you’re 55 may not sound ideal. However, in reality, it’s one of the most tax-efficient methods of cutting your tax bill as well as saving for retirement.
The personal allowance is restricted by £1 for every £2 of income beyond £100,000. What determines the £100,000 threshold? The answer is adjusted net income. What is adjusted net income? The answer:
Total taxable income
- Trading losses
- Gross private pension contributions
- Gross employee pension contributions made through work (relief at source scheme)
- Gift aid donations (see the section below)
Net adjusted income
By making additional pension contributions, the net adjusted income is reduced, which could bring back part or all of the personal allowance—see the example below.
Private pension contributions attract a 25% top-up by the government, meaning that, ordinarily, you can contribute a net maximum of £32,000, which is topped up by £8,000 (25%) by HMRC, resulting in gross contributions of £40,000 in a tax year.
The 25% top-up is the government’s method of providing basic rate (20%) tax relief on the gross contribution. Higher and additional rate taxpayers can claim further relief by way of the tax bands being increased by the gross contributions to receive total tax relief of 40% or 45% of their gross contributions.
Whether you opt for a workplace pension scheme or a private pension scheme, the tax rebates remain the same; however, if you aren’t contributing to an employer pension scheme, you are certainly missing out on an employer pension contribution that is free of taxes.
It is important to note that the annual pension allowance is £40,000, which includes employee, employer, and private pension contributions.
The annual pension allowance of £40,000 is restricted for higher earners, such that for individuals with income over £240,000, the allowance is restricted by £1 for every £2 of income above this limit. The maximum restriction is £36,000, i.e., individuals with an income of £312,000 or more will have a pension allowance of £4,000.
Unused allowances from the previous 3 years may be available to utilise in the current tax year on top of the annual pension allowance.
CHARITABLE GIFT AID DONATIONS
As well as being a good deed, certain donations to charities or local churches can provide additional tax relief, provided they are made with gift aid attached. Gift aid donations and income tax relief work the same as private pension contributions. The government tops up donations by giving to the charity an additional 25% and the gross donation made by the individual donor increases the tax bands and reduces the adjusted net income.
Remember to keep a record of your donations to claim tax relief when you file your self-assessment returns. A list of HMRC-approved Charities can be found here:
There is no limit on the donations that can be made.
INVESTING IN START-UPS
By investing in start-ups, individuals cannot save their allowances; however, tax savings can be up to 50%. There are currently three start-up investment schemes in the UK:
- The Seed Enterprise Investment Scheme (SEIS) provides up to 50% income tax relief
- The Enterprise Investment Scheme (EIS) provides up to 30% income tax relief
- The Venture Capital Trust (VCT) provides up to 30% income tax relief
Additionally, if the start-up you invest in makes it big, you don’t have to pay any tax on the gains either, as long as the shares are held for at least 3 years.
Haggards Crowther cannot give any financial advice and therefore we recommend speaking with a financial advisor before making decisions on which pension scheme to invest in and/or making investments in companies.