There has been talk that the Government may look to reduce the rates of income tax at the next Budget as part of a pre-election vote winning strategy. This could see the headline rates of 20%, 40% and 45% reduced by 1 or 2%.
Not many people are aware that the highest marginal rate of income tax that you can pay in the UK is 67.5%. This marginal rate of income tax applies to people living in Scotland on income between £100,000 – £125,140. For the rest of the UK, the highest marginal rate is 60%.
This marginal rate comes about as a result of a rule introduced in 2009, which means that those with income over £100,000 will lose some or all of their personal allowance.
The personal allowance is the amount of income you can receive before you start to pay income tax. For every £2 that your income is over £100,000 you lose £1 of your personal allowance, until it is completely lost at income of £125,140.
This means that someone in England, Northern Ireland or Wales earning £100,000 who gets a £10,000 pay rise will see the additional amount taxed at an effective rate of 60%, whereas someone earning £200,000 who gets the same pay rise would only pay 45% on the additional income.
Fiscal drag has meant that more people have been subject to a reduced personal allowance. The £100,000 threshold has not changed since 2009 and would now be over £150,000 if it had increased in line with inflation.
There are ways to mitigate the potential loss of your personal allowance.
The £100,000 threshold applies to your adjusted net income. This is your total income before allowances or tax-reliefs. You could therefore make a personal pension contribution to bring your adjusted net income down and reclaim all, or some, of your personal allowance.
For example, if your total income is £120,000 then a personal pension contribution of £16,000 net (£20,000 gross) would reduce your adjusted net income to £100,000. This would allow you to reclaim all of your personal allowance, saving you £2,000 in income tax, on top of the usual pension contribution tax relief.
Pensions are a tax-efficient way of saving for your retirement so contributing to a pension may be suitable as part of a wider financial planning strategy.
Charity donations that qualify for Gift Aid also work in a similar way, without the benefit of building up a pot of money for your retirement.
If you are affected by the loss of your personal allowance, then get in touch with your Financial Planner to discuss how you could mitigate this.
Just a reminder for any contributions you would like to pay in this tax year, please do get in touch with us prior to 5th March 2024 to allow us enough time to implement your request.
