Is it Possible to Avoid the Higher Tax Bracket?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices
In 2018, the Budget announced that the threshold at which people start paying the Higher Rate of income tax would rise. Rather than paying 40% after an individual’s income reached £46,350, the new threshold would be £50,000.
In 2020-21, the Higher Rate threshold rose slightly further to £50,270. Now, in 2024, the rates are frozen until 2028. As such, tax planning has arguably become even more important as the effects of fiscal drag take effect.
Our financial advisers in Lincoln are currently enjoying more conversations with clients about whether (and how) people can legitimately stay out of the Higher Rate tax bracket. With a bit of careful financial planning, we will show you how.
Make sure you consult with an independent financial adviser before making any big financial decisions, especially concerning pensions, estate planning and investments.
Using a Pension
The government wants to actively encourage people to save into a pension by offering tax relief on pension contributions. Saving into a pension is a great way to reduce your Income Tax bill while laying a stronger financial foundation for your retirement.
For instance, suppose you earn £60,271 in 2023-24. That means £10,000 will likely be taxed at the Higher Rate (40%). However, if you can afford to put all of that into a pension, then this money will not be taxed. In fact, the money that would have otherwise gone to the government in tax will be going into your pension instead.
In the above case, for instance, 40% of £10,000 would have gone towards the government in tax had it not been put into your pension (i.e. £4,000). However, because you put the money into your pension, that £4,000 goes towards your pension instead.
In effect, it costs you £6,000 to put £10,000 into your pension pot!
If you work full-time for an employer, they can arrange all of this via PAYE (Pay As You Earn). However, if you have a personal pension or SIPP, you will need to make arrangements with the pension scheme. Here, we recommend taking professional advice from your financial adviser.
Obviously, the more you earn throughout your career, the more you may have to put aside towards tax-efficient vehicles such as a pension if you want to avoid the Higher Rate bracket. If you earn £90,000 per year, for instance, you might need to consider putting nearly £40,000 into a pension to avoid the Higher Rate.
However, if you earn more than that, you could still rely on a pension to circumnavigate the Higher Rate. Our financial advisers in Lincoln often point out to people that you can exceed the annual allowance by utilising “carry forward” – using the previous years’ three annual allowances (if you have been a member of a pension of something description during this period) up to the value of your current annual earnings.
Options beyond Your Pension
For those in the aforementioned situation, options that allow you to legitimately save on tax are still open to you. Here are some ideas our Lincoln financial advisers have discussed with high-earning clients. (As before, speak with your own independent financial adviser prior to making any big investment/financial decisions):
#1 Salary sacrifice
Although restrictions on salary sacrifice schemes have increased in recent years, these schemes can still be an attractive option to consider.
Essentially, you give up some of your salary in exchange for a benefit paid for by your employer. For instance, this might include extra pension contributions from your employer.
Reducing your salary, of course, means reducing your Income Tax Bill. So if you can afford to maintain your lifestyle whilst reducing your pay in exchange for these kinds of benefits, it’s worth considering. However, be mindful that there are downsides to salary sacrifice schemes. For instance, it will likely mean you can borrow less on a mortgage, and it can reduce the value of life cover through a work scheme.
#2 EIS & VCT
The Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT) were introduced in 1994 and 1995, respectively. They both allow you to invest tax-efficiently into small businesses and startups.
These types of investments are inherently more risky than others (e.g. government bonds), so you should consult with your independent financial adviser before investing in any of these vehicles.
EIS investments are made by you, the individual investor. Provided you hold the shares for at least 3 years, you can claim up to 30% Income Tax relief in a tax year on EIS investments worth up to £1m. You also get tax relief on any dividends and capital gains you make and after two years can be exempt from Inheritance tax.
VCTs are similar to the EIS scheme, except a fund manager manages the investments. Here, you must hold investments of up to £200,000 for 5 years to receive 30% Income Tax relief in a tax year.
#3 Charitable Gifts
Charities offer a great way to give to those in need and provide a powerful means for Higher-Rate taxpayers to save on their tax bills.
Gifting to charity can effectively “widen” your Higher Rate tax window. For instance, suppose you are earning £55,000 in 2023-24. The 40% income tax rate would only apply to the excess earnings above £52,270 (with the original threshold being £50,270).
