Individuals earning between £100,000 and £125,140 could be paying tax at an effective rate of 60%. This occurs because you lose your tax free personal allowance of £12,750 at a rate of £1 for every £2 you earn above £100k. As a result of the tapering, individuals earning over £100,000 effectively pay a higher rate of tax on this portion of their income.
This tapering of the Personal Allowance creates a "disincentive zone" where the effective tax rate can be significantly higher within the income range of £100,000 to £125,140 and individuals may find themselves with a reduced net income in this range.
In addition to the 60% effective rate of tax on income over £100k, you may be aware that parents lose their entitlement to free childcare hours if one of their incomes goes over £100k, which provides a further disincentive.
How can this be avoided?
There are ways to avoid paying this 60% tax, through the use of pension contributions and Gift Aid donations. These methods can also preserve your entitlement to free childcare.
Both pension contributions and charitable donations (provided a Gift Aid claim has been made and the contribution is eligible for tax relief) reduce your ‘adjusted net income’, which is the income figure that is used to determine your tax-free personal allowance and your entitlement to free childcare.
Pension Contributions
When paying into pensions, individuals receive income tax relief on any contributions they make at the highest rate of income tax they pay (known as the marginal rate), provided the total gross pension contributions paid into their pension schemes (including contributions paid by employers and other people, as well as the individual’s own contributions) don’t exceed the lower of their annual earnings and the pensions annual allowance.
Pension contributions can be paid either through a workplace pension scheme, essentially as part of an employment, or by making personal pension contributions outside of an employment.
Charitable Donations
Cash donations made to charities via gift aid are treated as having been made net of 20% basic rate tax, meaning a cash donation to charity of £80 is a net donation of £80 and a gross donation of £100. If you are a higher-rate or additional-rate taxpayer, you will be eligible for extra tax relief as your basic-rate band is extended by the amount of gross donations made during the tax year.
The amount your ‘adjusted net income’ is also reduced by the gross amount of charitable donations made during the tax year.
You can also, in certain circumstances, elect to treat charitable donations as being made in the previous tax year, meaning that if your ‘adjusted net income’ ends up exceeding £100k in a tax year, you can potentially remedy this after the end of that tax year.
Contact Us
Please contact us to find out how the above applies in your circumstances and how you can reduce your tax liabilities and maximise your tax efficiency.
Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
