Autumn Statement – Income Tax considerations
The stealth increases to income tax by freezing the level of personal allowance, the basic and higher rate bands as well as reducing the additional rate threshold will mean millions of people will pay more tax. The freezing of these bands was already due to last until 2026 but the chancellor has extended this to at least 2028.
Individuals should aim to utilise all available allowances and it may be advantageous for couples to look at the ownership of their assets and income received from them to ensure both personal allowances, starting/basic rate tax bands and the dividend and personal savings allowances are used to the full.
24th November 2022
Raj Seewooruttun See profile
With frozen allowances, different tax bands and other measures interacting with each other there are several ‘cliff edge’ situations to pay careful attention to where the effective tax rates are much higher than the level expected.
For those with younger children and a salary above £50,000, if you or your partner are receiving child benefit, there is the High Income Child Benefit Charge (HICBC). For every £100 above £50,000 salary, this tax charge is 1% of the child benefit amount, which means that once your income reaches £60,000 the tax charge is the same as the child benefit received.
By making personal pension contributions and / or charitable gift aid donations, it is possible to effectively reduce your income and reduce the charge.
As an example, the effective rate of tax relief if you earn £60,000, have three children and make pension contributions to bring your salary down to £50,000 is over 65%.
- Salary of £60,000
- Child Benefit received for three children totals £2,636 but there is a corresponding tax charge of £2,636
- Making a personal pension contribution of £8,000 (£10,000 after basic rate tax relief is added) brings the effective salary for HICB down to £50,000. Higher rate income tax relief can be claimed through self-assessment so the cost for making this contribution is £6,054. There is £10,000 in the pension and the charge of £2,636 is not due.
- The effective rate of taxation between £50,000 and £60,000 is £6,582 which is over 65% of £10,000 and even greater savings can be made by using salary exchange to make the contribution with reductions in national insurance for the employee (and the employer).
For higher earners with income exceeding £100,000, the personal allowance also starts to be taken away. Where income falls between £100,000 and £125,140, the marginal rate of tax is 60%. By reducing your taxable income through making pension contributions or gift aid donations you can reclaim the entitlement to the personal allowance which is worth over £5,000 per annum to a higher rate taxpayer. Effective tax relief at 60% in the current climate is very generous.
Above £125,140, the rate of tax relief isn’t quite as high, but at 45% it is still very attractive.
If you have young children, bringing your income under this £100,000 threshold also allows you to claim up to £2,000 in tax free childcare per child each year so the effective rate of tax relief can be even higher.
As can be seen, making pension contributions is a great way to secure some very attractive tax benefits. The annual pension allowance in this era of rising taxes is unlikely to get any more generous than it is currently which makes it all the more important to take advantage of the current rules in case they change in the future for the worst.