As economic pressures grow, ‘middle’ Britain is being taxed more. This piece is particularly relevant to those earning £100,000 and more.

Situation 1: Losing your personal allowance

You’ll be paying an effective rate of 60% tax on your income between £100,000 and £125,000 in the 19/20 tax year. This is because as your income goes over £100,000, you begin to lose £1 of your personal allowance of £12,500 for every £2 it’s over £100,000.

Therefore, once you reach £125,000 you don’t have any personal allowance left. The £12,500 is pushed into the 40% tax bracket incurring a tax liability of £5,000 which you previously wouldn’t have incurred. The £25,000 over your £100,000 income also incurs a 40% tax liability which gives £10,000 to the taxman.

That’s a total of £15,000 to the taxman for simply having an additional income of £25,000 over £100,000. This equates to an effective tax rate of 60% (£15k/£25k).

Who needs to watch out? If you are trader/stockbroker or someone who benefits from a high bonus at the end of the tax year that could push you into this category.

What can you do? Make a pension contribution and you’ll receive an effective 60% tax relief. If you are employed, you only need to make a net contribution of £20,000 and not only would you receive a £5,000 tax boost into your pension, you can claim higher rate tax relief when you complete your self-assessment. You also get your personal allowance back as your ‘adjusted net income’ falls to £100,000. If you are self-employed operating via a limited company, just make a gross contribution via your company for the extra £25,000 you would’ve taken as PAYE or Dividends.

Situation 2: Losing your annual allowance for pension contributions

This is one is a little more complicated, does require closer attention. It affects top-rate taxpayers.

We can make a pension contribution into a UK registered pension up to £40,000 per year and receive tax relief on the contribution; this is called the ‘Annual Allowance’.

However, if your ‘adjusted income’ (which is your taxable earnings and any employer pension contributions), is over £150,000 per year, the annual allowance, tapers by £1 for every £2 your income goes over £150,000.

Generally, when your income exceeds the £150,000 mark by £60,000 (by having an annual income of £210,000), your annual allowance is reduced to only £10,000 per year; under current legislation this is the maximum it can be reduced to. Therefore, you only receive tax relief on £10,000.

Any reduction to your annual allowance means you ‘suffer’ the ‘tapered annual allowance’ (TAA). If you contribute above your TAA, that contribution will suffer a tax charge of 45%!

If you are a business owner who is a top rate taxpayer with an adjusted annual income of £210,000 of which part of that income includes an additional £20,000 of dividends and £20,000 of company pension contributions…

You incur 38.1% dividend tax on the £20,000 which gives a tax charge of £7,620.

You also incur a 45% TAA tax charge on the excess £10,000 company pension contribution which is £4,500.

That’s a total charge of £12,120 which is effectively c60% (£12,120/£20,000). You’re paying c60% tax charge for making a pension contribution whilst your adjusted income is at £210,000.

Who needs to watch out: All top-rate taxpayers.

What can you do?

  • If you take £20,000 less dividends, your adjusted income reduces to £190,000, and your TAA increases to £20,000. Therefore, the employer pension contribution would not suffer a 45% tax charge.
  • Don’t make a pension contribution for yourself.
  • Make a pension contribution for your spouse provided he/she is a lower rate taxpayer.
  • Dependent on your risk profile, you may want to consider a Venture Capitalist Trust (VCT) or an Investment Bond.

Mohammad Uz-Zaman is a private client trust and estate planning consultant who holds accreditations across regulated financial advice and estate planning. He holds graduate and post-graduate degrees and he is also an associate member of the Society of Trusts and Estate Practitioners (STEP). He works closely with financial advisers, general practice solicitors, accountants and investment managers from several major practices.

Disclaimer: Nothing in this piece should be taken as personal financial advice. Seek professional advice, everyone’s circumstances are different. Pay for good quality financial advice, you’ll save thousands and you’d avoid an argument with your spouse if you had acted on your own and made a stupid mistake. You’ll also have recourse to the Financial Ombudsman Service if the advice you were given by a regulated financial adviser was wrong. Remember, you don’t know what you need to know. ADL Estate Planning Ltd does not provide any regulated financial advice.

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