The hidden 60% and 73% tax rates: Atkins Ferrie Wealth Management explain that with a little planning, there are ways to reduce your liability.
Here in the UK, the top 50% of taxpayers account for 90.5% of the total tax receipts, with 85% of taxpayers liable for basic rate, 13% higher rate and 2% additional rate income tax. While most of us would agree that tax is important to provide and maintain our public services, there are some instances where those with relatively modest incomes are being taxed more than the very wealthy.
High Income Child Benefit Charge is the first. Child Benefit remains universal, however if you have an adjusted net income of more than £50,000 and you or your partner claim Child Benefit, you may have to pay a tax charge known as the ‘High Income Child Benefit Charge’. For those with an adjusted net income between £50,000 and £60,000, this is 1% of the total benefit for every £100 of income over £50,000. Those earning over £60,000, effectively receive no Child Benefit at all. The charge applies to the partner with the highest adjusted net income, regardless of who actually receives Child Benefit.
Take Mr and Mrs Smith, for example. They have four children under the age of 16, for which Mrs Smith claims £3,270.80 a year in Child Benefit. While Mrs Smith does not work, Mr Smith has a basic salary of £50,000. His employer generously awards him a bonus of £10,000, which brings his total adjusted net income to £60,000. As a result, not only will Mr Smith be liable to £4,000 additional income tax, but they will also lose 100% of their Child Benefit. This results in an effective tax rate of 73% on Mr Smith’s bonus.
The second instance is Personal Allowance Reduction. Your personal allowance is the amount of income you can earn in a year without any liability to income tax. What people often do not realise is that your allowance gradually reduces to nil if you earn £100,000 to £125,000 (2020/21). This means the effective rate of tax for these earners is 60%. Your allowance is reduced by £1 for every £2 earned over £100,000.
As an example, Miss Phillips has a basic salary of £100,000. During the year she receives her annual performance-related bonus of £10,000. Not only will she be liable for the higher rate 40% tax (£4,000) she will also lose £5,000 of her personal allowance, resulting in a further £2,000 income tax. This results in an effective tax rate of 60% on Miss Phillips’ bonus.
So how can these rates be mitigated? Often the most efficient solution is an additional pension contribution. In the earlier example looking at Mr and Mrs Smith’s Child Benefit, if Mr Smith contributed £10,000 gross into a pension, the High Income Child Benefit Charge would be negated entirely. This means he can add £10,000 into his pension for a ‘real’ cost of only £2,729.20.
Likewise, Miss Phillips could contribute £10,000 gross into her pension, which would then keep her personal allowance intact. This means she can add £10,000 into her pension for a ‘real’ cost of only £4,000.
Of course, this is one of a number of solutions to the above dilemmas. Other options are available which reduce your overall tax liability without locking the funds up for retirement. Tax planning is, however, a complex area with many interlinked issues, so if you would like to discuss your options or would like help or advice, it makes sense to call the advisers at Atkins Ferrie Wealth Management on 01872 306422 to book your initial review and consultation.