If you are a high-income earner, it is important you know how to calculate your personal allowance over £100,000 as it’s a common misconception that the highest rate of effective income tax one can pay is 45%. In fact, due to a quirk in the tax rules, there are two scenarios where individuals are effectively paying up to 60% tax rate on part of their earnings – and it’s affecting more and more people.
Calculating your personal allowance over £100,000 is just one aspect of your finances we will consider when you seek wealth planning advice from our expert team of independent financial advisers. Once you know just how much tax you are paying, we can consider if there are any simple financial planning actions you could take to manage this. It is important to note that ‘income’ is not just your salary, but includes all income that is chargeable to income tax, such as earnings from investments, savings income and chargeable events – our independent financial advisers can give you further details.
In this article, Head of UK Financial Planning, David Goodfellow, explores the two scenarios that can cause you to pay the 60% tax rate and provides our top tips if you are caught by them.
How to calculate your personal allowance over £100,000 to manage the 60% income tax rate and avoid the 'personal allowance trap'
Each year you have a ‘personal allowance’ which is free of income tax. If you earn £100,000 pa or less*, you could be entitled to the full personal allowance of £12,570 and your income tax position could look like this:
However, under rules announced in 2010, your personal allowance reduces by £1 for every £2 you earn above £100,000. If you earn £125,140or more, you’ll lose your personal allowance altogether. And somewhere in between £100,000 and £125,140you could find yourself in the 60% tax rate personal allowance trap.
To illustrate this point, if you earn £110,000 pa your position could look like this:
The extra £10,000 salary means that:
- The £10,000 is taxed at 40% – an extra £4,000 tax
- You also lose £5,000 of your personal allowance due to the £1 reduction for every £2 of extra salary over £100,000; this would also now be taxed at 40% – an additional tax of £2,000.
The extra tax would be £6,000 for £10,000 extra earnings – a rate of 60%.
* Please note: different rates apply in Scotland.
How to calculate your personal allowance to avoid the ‘child benefit income tax trap’
More and more people are getting caught by the child benefit income tax trap, with data from the Institute for Fiscal Studies showing that over 1.3 million families were caught in the 2018/19 tax year[1] by the withdrawal of child benefit – which effectively impacts your personal tax allowance.
If you get child benefits, you could face a ‘high income child benefit tax charge’ of 1% for each £100 you earn above £50,000, so the benefit is cancelled out by the time you earn £60,000.
For example:
If you have two children and each parent earns less than £50,000 a year, you’d receive approximately £1,820 in child benefits.
However, if one of you received a pay rise of £5,000, you would lose £910 in child benefit, since you incur a ‘high income child benefit tax charge’ of 50%. Because your salary is in the higher rate tax band of 40%, the £5,000 would be taxed at 40% = £2,000. So, your £5,000 pay rise would effectively cost you £2,910 – a tax of 58.2%.
How to manage the 60% tax rate if you are caught by these income tax traps
Our independent financial planners will work with you to develop a robust wealth management plan which will consider all aspects of your finances, including how much tax you need to pay, including income, capital gains and inheritance tax planning. They will also consider any tax reliefs which are available to you, such as your annual pension contribution or lifetime allowances, and you may be able to make use of unused pension allowances. If you would like a free consultation, contact us.
There are some other actions you can take yourself, to manage the 60% tax rate:
1. Reinstate your personal allowance by contributing more into a pension
The level of income used for assessing how much personal allowance or child benefit you are entitled to is calculated after deducting the gross amount of any pension contributions you have made in that tax year. So, if your earnings were £110,000 pa and you decided to contribute £10,000 (gross) personally into a pension, you would reinstate your personal allowance and you’d be £6,000 better off².
2. Reduce your cash pay from your employer
This arrangement, known as salary sacrifice, has the advantage of reducing both the income tax you pay and the national insurance you and your employer may pay. Simply reducing your take-home pay through salary sacrifice could work to reinstate your personal allowance or child benefits.
3. Make gifts to charities under Gift Aid rules
This can have a similar effect. What is more, these could be backdated to the previous year, so long as the donation is made before the tax return for that year is filled.
If you’d like to find out more about income tax and how you can avoid the traps, get in touch with us.
If you found this interesting, you might also want to read:
- Mitigating tax rises post-COVID-19
- Guide to inheritance tax planning
- Calculating inheritance tax with our IHT calculator
- Five top tips for managing IHT
- Boost your pension by making use of unused pension allowance
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The tax treatments set out in this communication are based on our current understanding of UK legislation. It is a broad summary and cannot cover every circ*mstance and it does not constitute advice.
Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
The information contained herein is based on materials and sources that we believe to be reliable, however, Canaccord Genuity Wealth Management makes no representation or warranty, either expressed or implied, in relation to the accuracy, completeness or reliability of the information contained herein. All opinions and estimates included in this document are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information contained herein.
[1] Source: https://www.ifs.org.uk/uploads/publications/bns/BN247.pdf
[2]Income in excess of £100,000 is subject to both higher rate tax of 40% (£4,000) and will also result in a partial loss of the Personal Allowance, £12,570 in the 2022/23 tax year, which is tapered down by £1 for every £2 of income in excess of £100,000 (see scenario A in table below).
A total income of £110,000 (Scenario A) would result in a £5,000 reduction on the Personal Allowance, incurring a further higher rate tax charge at 40% (£2,000).
Therefore, without any pension provision, the £10,000 excess income would be subject to a combined tax charge of £6,000 or an effective tax rate of 60%.
A gross pension contribution of £10,000 (scenario B in table below) would have the effect of reinstating the Personal Allowance in full, whilst providing tax relief at a higher rate, thus saving £6,000 in income tax (see the differene between scenario A and scenario B in table below) .
This results in a £5,000 loss of personal allowance, or in tax terms, £2,000 of additional tax due (40% of £5,000).
Therefore, in total this £6,000 tax on the £10,000 would be mitigated by making a gross contribution of £10,000 into a pension (see scenario B in overall table below).
Scenario A (income = £110,000) | Scenario B (income = £100,000) | |||||
Band | Amount | Tax Rate | Tax | Amount | Tax Rate | Tax |
Personal Allowance | £7,570 | 0% | £- | £12,570 | 0% | £ 0 |
Basic Rate Band | £37,500 | 20% | £7,500 | £37,500 | 20% | £7,500 |
Higher Rate Band | £64,930 | 40% | £25,972 | £49,930 | 40% | £19,972 |
Total | £110,000 | 30.43% | £33,472 | £100,000 | 27.47% | £27,472 |
Overall | ||
Scenario | A | B |
In pocket | £76,528 | £72,528 |
Pension Contribution | £0 | £10,000 |
Total | £76,528 | £82,528 |
