Most people are of the opinion that the highest rate of UK Income tax is 45%, however there are a few situations where the amount is significantly higher than this and most people are in them without even realising.
The UK's complicated tax system means that some end up paying 60% on a portion of their income and this tax isn't reserved for the super rich as there are an estimated 650,000 that fall into this trap.
CHILD BENEFIT
Families where one partner earns more than £50,000 a year face a tax charge of 1% of their child benefit for every £100 earned between £50,000 and £60,000.
If you have two children and the higher earner earns £50,000 a year, you’ll receive almost £1,790 per year in child benefit. But if you earn £1,000 extra, this costs you £179 in child benefit, as well as £400 in income tax.
That’s £579 in total – an effective tax rate of 57.9%.
What can you do about it?
Using the above example, you could make a £1,000 pension contribution, which would mean that you wouldn't pay the £179 tax charge on the Child Benefit and you'd also receive 40% tax relief on your contribution;
Specifically;
- You make an £800 payment
- The government adds £200
- As a higher rate tax payer you can reclaim the additional 20% tax
- This means your £1,000 gross payment costs you £600 net.
- You also save £179 as the Child Benefit wouldn't be taxed
Altogether bringing your net payment to £421, for a £1,000 pension contribution, therefore saving 57.9% tax.
PERSONAL ALLOWANCE
This can impact an estimated 250,000 people.
If your earnings for the year are under £100,000, you should benefit from a Personal Allowance of £12,500, which means that the first £12,500 of your income isn't taxed.
Once your income goes above £100,000, the Personal Allowance tapers away at a rate of £1 for every £2 that your earn. This means that by the time your income reaches £125,000, your Personal Allowance is zero.
This effective tax rate is 60%.
What can you do about it?
Again, pension contributions can help.
If your earnings are between £100,000 and £125,000 then a £1,000 pension contribution would work out as follows;
- You make an £800 payment
- The government adds £200
- As a higher rate tax payer you can reclaim the additional 20% tax
- This means your £1,000 gross payment costs you £600 net.
- Reducing your income below the £100,000 limit means your personal allowance is reinstated, saving you a further £200 in tax.
Altogether bringing your net payment to £400, for a £1,000 pension contribution, therefore saving 60% tax.
IMPORTANT THINGS TO CONSIDER
A pension is a long term investment and therefore any money contributed, cannot be accessed until you are at least 55 and for some aged 57/58.
Is a pension contribution a sensible strategy. Do you have short term debts (credit cards etc) that might be cleared instead.
Which scheme should I contribute towards? If you have multiple schemes, what are the charges on each of them. Do any of the contracts charge an Initial fee?
How much can i save into my pension? Check out our blog on pension allowances.
As always, seek independent financial advice before proceeding.
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