Everyone would like to pay less tax, but for those earning over £100,000, the options start to reduce. For example:
- Anyone earning over £100,000 will start to lose their personal tax-free allowance.
- As a higher-rate taxpayer, you can only claim £500 in tax-free savings interest (rather than £1,000). If you are an additional rate taxpayer, the allowance is reduced to nil.
- You are not eligible for Marriage Allowance.
- Child benefit and tax-free childcare are no longer available.
- At £125,140, you will start to pay 45% tax on your top tier of income.
- At £240,000, the amount you can pay into a pension will also start to reduce.
This means that tax planning is usually a high priority for anyone earning over £100,000. In this guide, we look at some of the ways in which you can reduce your tax bill.
Top Up Your Pension
Pensions are one of the most tax-efficient ways to save for retirement, especially for higher-rate taxpayers.
For every £80 you contribute personally, you receive tax relief of £20. Higher and additional rate taxpayers can claim additional relief – this means that your contribution of £100 could cost as little as £60 (or £55 for an additional rate taxpayer) from net income.
But even more significantly, making pension contributions can bring your earnings under £100,000, meaning your personal allowance will be restored. As the effective tax rate at this level is 60%, your pension contribution of £100 will only cost you £40.
If you are paying into a workplace scheme, making your contributions through salary sacrifice can also save on National Insurance, both for you and your employer.
If you run your own company, making employer contributions can also save on corporation tax.
Your pension fund grows free of tax, and when you reach minimum retirement age, you can take 25% of the pot as a tax-free lump sum. The remaining income is taxable only when you withdraw it.
Of course, there are a few limitations on how much you can contribute:
- Personal contributions are capped by your relevant UK earnings (i.e. salary or trading profits).
- Personal and employer contributions are further limited by the annual allowance of £60,000. However, unused allowances can be carried forward by up to three tax years if you are already a member of a pension scheme.
- Anyone earning over £240,000 will have a reduced annual allowance. This is tapered at a rate of £1 for every £2 earned over the threshold. The minimum annual allowance (for anyone earning over £312,000) is £10,000.
- If you have already taken flexible, taxable benefits from your pension, your annual allowance will also be reduced to £10,000. Additionally, you lose the option to carry forward.
Providing you remain within the limits, effective pension planning can save significant amounts of tax.
Invest Tax-Efficiently
Once you have maximised your pension, there are a number of other tax-efficient investment options to choose from:
- Contribute up to £20,000 to an ISA. Income and growth are tax-free, and you can take the money out without penalty.
- For general investment accounts and share portfolios, aim to make use of your capital gains exemption. This is currently £6,000 (reducing to £3,000 from April 2024). You can do this by switching funds, making withdrawals, or moving investments into your ISA.
- Consider investment bonds for larger lump sum investments. No personal tax is payable while the funds are invested (although UK bonds do pay some tax within the funds). Tax can sometimes apply when you make withdrawals, but bonds offer many opportunities for planning.
- If you can afford to take more risk with some of your money, you may want to consider Venture Capital Trusts or Enterprise Investment Schemes. Both offer significant tax benefits by investing in smaller companies. This is a high-risk option and should only be considered if you can afford to lose the money.
Joint Planning with a Spouse
While Marriage Allowance is no longer an option for higher and additional rate taxpayers, there are still a few possibilities for joint planning to save on tax:
- Owning assets jointly means that you have two sets of allowances to set against interest, dividends, and capital gains.
- Passing assets to a spouse is not subject to capital gains tax, which offers more tax planning opportunities.
- If your spouse earns less than you, or is in a lower tax band, you may want to hold more income-producing assets in their name to reduce the overall tax bill.
Donate to Charity
Many people make charitable donations without really thinking about the tax benefits. But for higher earners in particular, making gifts to charity can bring significant tax benefits. For example:
- Charitable donations work in a similar way to pensions for the purposes of income tax relief. If you claim Gift Aid, for every £80 you donate, the charity can claim back an additional £20 from HMRC. Higher and additional rate taxpayers can claim further relief through self-assessment.
- If you donate assets instead of cash, any capital gains tax liability will be wiped out.
- Charitable gifts are immediately outside your estate for Inheritance Tax purposes.
If you were already planning on making gifts to charity, it’s a good idea to build this into your tax plan. You can save substantial amounts of tax as well as helping good causes.
There are multiple ways to save tax as a higher earner, although looking at this as an end goal can sometimes be counterproductive. A financial adviser can help you build a tax plan that fits in with your current lifestyle as well as bringing you closer to your objectives.
Please don’t hesitate to contact a member of the team to find out more about tax planning.
