This content is for inspiration and information purposes only. It should not be taken as financial advice. To receive bespoke, regulated advice regarding your financial affairs and goals please consult with one of our Sale-based financial planners here at Suttons IFA.
The level of income tax you pay can make a big difference in your quality of lifestyle. So it’s understandable that our clients often ask us whether there are legitimate ways to ease the burden. To quickly recap, here are the income tax brackets for 2019-20:
- Income up to £12,500 is tax-free. This is known as your Personal Allowance, and you are entitled to it until you start earning over £100,000. For every £2 you earn over this amount, £1 will be deducted from your Personal Allowance.
- Earnings between £12,501 and £50,000 are taxed at the 20% Basic Rate.
- Income between £50,001 and £150,000 faces the Higher Rate of 40%.
- Anything over £150,000 is taxed at the Additional Rate (45%).
Please note that the tax brackets are different in Scotland.
For those in the Higher Rate tax bracket, the question is often asked whether it is possible to avoid overpaying on taxes and thus leave more to support your family. In this short guide, our Sale-based financial planners here at Suttons IFA will be sharing some ideas which you might want to discuss with your financial adviser.
If you would like to find out more or discuss your own financial plan with us, please get in touch today to arrange a free, no-commitment financial consultation with a member of our team.
Remember, most people will pay income tax based on their salary. So, if your salary is reduced then it follows that your tax should also be lowered. Following this logic, if there is a way to attain certain benefits in exchange for an amount of your salary (which would have gone towards paying for those benefits anyway), then you could potentially reduce your income tax bill without necessarily compromising on some of the things you want.
The classic strategy used here is “salary sacrifice” schemes, where you forgo a certain amount of salary in exchange for particular benefits offered by your employer. For instance, perhaps you could reduce your salary in exchange for a company car or for childcare vouchers. This can be an attractive option for your employer too in many cases, as a reduction in your salary is likely to require them to pay lower National Insurance contributions.
If your salary is sitting just above the Higher Rate such as £52,000, then you could effectively “escape” the Higher Rate by reducing your salary by £2,000 under a salary sacrifice scheme. Be careful to consult your financial adviser, however, before committing to anything. Remember, reducing your salary can have dramatic consequences in other areas of your life, such as mortgage applications.
Your pension can be one of the most powerful tools at your disposal for reducing your tax bill, as well as saving for your future. Similar to the example above, any excess income over £50,000 could conceivably be put into your pension to avoid the Higher Rate.
So, suppose you earn £70,000. In this situation, £20,000 of your income is likely to be subject to 40% Higher Rate Tax, resulting in an £8,000 bill. Furthermore, £37,500 would face the 20% Basic Rate, leading to a further £7,500 lost to tax; totalling £15,500.
However, imagine you committed at least £20,000 of your £70,000 salary into your pension. That means none of your income is subject to the 40% Higher Rate and you would save £8,000. The way this would work is you would make a pension contribution of £16,000 and 20% tax relief (£4,000) would be added automatically to the contribution so that £20,000 is paid in. You would then reclaim the additional 20% (£4,000) from HMRC giving total tax relief of £8,000.
Now, imagine your salary is £125,000. Due to the loss of your personal allowance, the top £25,000 of your salary is effectively being taxed at 60% resulting in a tax charge of £15,000. This tax could be reclaimed by making a personal pension contribution of £20,000. £5,000 would be added automatically so that £25,000 is paid into your pension fund and the additional higher rate relief of £10,000 would paid to you by HMRC giving total tax relief of £15,000.
In addition to being able to make significant tax savings, any pension contributions you make helps in building up your savings for retirement.
At this point, it’s important to state that this is just an illustrative example and should not be taken as a recommendation about how to deal with your pension. However, it hopefully serves to show how pensions can be leveraged to ease your tax bill, whilst helping to prepare your finances for retirement.
These are just a few strategies to consider with your financial planner if you are interested in reducing your Higher Rate tax bill. Other options you might think about include investigating tax-efficient investment vehicles, such as the Enterprise Investment Scheme (EIS) or Venture Capital Trusts (VCTs). It’s worth noting, however, that these routes tend to carry a higher level of investment risk and so should be considered carefully within the context of your wider portfolio.
Charitable gifts can also be an option if you are thinking about reclaiming some of your Higher Rate tax payments. Remember, in 2019-20 the UK government offers tax relief to those who donate to charity. This means that you can claim back the difference between the Higher Rate and the Basic Rate on the value of your donation.
So, imagine you donate £4,000 to charity in a given tax year and your salary is £54,000. The difference between the Higher Rate and the Basic Rate is 20% (i.e. 40% – 20%), so you could claim back 20% of your £4,000 donation (i.e. £800).
Interested in speaking to a financial adviser about how to make your finances more tax-efficient? Get in touch today to arrange a free, no-commitment consultation with one of our Cheshire-based financial planners here at Suttons IFA:
T: 0161 969 1703
E: [email protected]