Having sucessfully run a webinar recently for staff about the taxation on high earners, we though that we would post the content here as a permanent record.
The £100,000 Problem
Earning over £100,000 can be very painful from a tax perspective. Your earnings between £100,000 and £125,140 are taxed most heavily of anyone in the UK tax system. This is because, normally, everyone is entitled to a tax-free personal allowance of £12,570 each year. However, when your total income goes above £100,000 you begin to lose your personal allowance at the rate of £1 for every £2 you are over £100,000. This means that once your total income goes above £125,140 you have lost your personal allowance.
Anything you earn between £100,000 and £125,140 is therefore effectively taxed at 62% (40% income tax, 20% loss of personal allowance and 2% national insurance). The situation is even worse in Scotland due to the higher rate of higher rate tax, the tax rate is an effective 63%. This will become even worse from 6 April onwards with the introduction of the ‘Advanced’ tax rate, meaning an effective tax rate of 67.5%. Losing two thirds of your income to tax is not a particularly appealing incentive to work!
The figures above are even worse still if you have a student loan, to which you can add a further 9% tax. The above is also applicable to all income i.e. if your salary and bonus is exactly £100,000, if you also rent out a property any rental income received will reduce your entitlement to the personal allowance.
The situation unfortunately gets worse if you have children (at least in England).
In England, 3-4 year-olds are currently entitled to 15 hours free childcare per week, though working families can claim an additional 15 hours. 30 hours of free childcare is being phased in slowly – by September 2025 children over the age of 9 months will be eligible for 30 hours per week. However, if your income (or your partner’s income) is over £100,000 you are not entitled to the additional 15 hours of free childcare. You also lose access to the £2,000 tax-free childcare top up. This can mean that, for families with children, earning just £1 over £100,000 will mean you are thousands of pounds worse off. For a parent in London with 2 children, you could be as much as £20,000 worse off for £1 additional salary.
To clarify Scotland does not have the same £100,000 cut off for childcare that England does (you won’t lose the free hours) however you will lose access to the £2,000 tax-free top up.
Solutions
Luckily, there are a few ways we can fix this. You can reclaim both your personal allowance and your eligibility for childcare by reducing your adjusted net income back below £100,000. As a reminder, you need to include all sources of income, including any dividends, rental income, interest income etc. Things you can do to reduce your adjusted net income include:
- •Making pension contributions (you can only deduct your contributions not those from Phoenix)
- •Donating money to charity via Gift Aid
- •Making use of the Phoenix SIP (not Sharesave as that is made out of post tax income)
- •Any other salary sacrifice schemes – for example Phoenix offers an EV car scheme Of all those listed above, pensions are most widely used. A pension contribution when your earnings are in tax trap range is particularly powerful. As an example, in England, you will receive effectively 62% tax relief on any pension contribution. This is made up of 40% higher rate tax relief, 2% national insurance and restoring your personal allowance. When you come to draw this money in retirement you will be able to access 25% of this tax-free with the rest subject to income tax, probably at the basic rate of income tax, so you end up only paying 15% on the way out of the pension compared to the 62% relief you got in the way in (more in Scotland!).
You can pay up to £60,000 per year into a pension. This figure includes pension contributions made by Phoenix so you do need to be careful. Therefore, we usually recommend that if you are able to redirect earnings to your pension and keep under £100,000 you should do so. You are able to carry forward 3 years’ worth of allowances. The allowance in previous years was £40,000 so you might have more scope to do this than you might think. To use carry forwards, you must use the current tax year’s allowance first followed by the furthest back (i.e. 3 tax years ago, so 20/21) first. Then 21/22 and finally 22/23. You cannot pick and choose which ones to use up.
If your total income is around £150,000 you are probably just about able to keep your adjusted net income under £100,000 by making use of other salary sacrifice schemes along with pension contributions. Beyond this point you may have to accept that there is not much you can do once all your pension allowances are used up. As your earnings grow the 60% tax trap will become less of a problem.
The £260,000 Problem
Once your threshold income is above £200,000 and your adjusted income is above £260,000 your annual allowance begins to be tapered. Tapering works similarly to the personal allowance, the annual allowance is reduced by £1 for every £2 your adjusted income is above £260,000. This continues until £360,000 at which point you cannot be tapered further, leaving an annual allowance of £10,000.
Threshold income and adjusted income are not straightforward to work out. The key point is they include all forms of income, including rental, dividend and interest income. You also need to add back nearly all salary sacrifice deductions and (for adjusted income) employer contributions. The main difference between the two is how they treat certain types of pension contributions (we have another blog about this which goes into more detail on this site).
Once you begin to be affected by the tapered annual allowance, you should try to utilise all pension allowances you have available, particularly if your earnings are expected to increase in the future and your annual allowance reduces. As explained above, you are able to carry forward any used annual allowance from the 3 previous tax years. You should try and ensure you at least use the current year’s allowance (23/24) and the furthest back year (20/21). You should try and keep doing this until you have no more carry forward left to use as your pension contributions are going to be severely restricted in future, particularly if you still expect your income to grow.
Once you have adjusted income over £260,000, there isn’t anything you can do to regain the full pensions annual allowance (unlike with the £100,000 problem) other than not have the income in your name in the first place.
More Solutions
So what can you do instead to make your investment’s as tax-efficient as possible? A couple of ideas are discussed below:
- •If you are married you can use your spouse’s pension allowance. This will be either 100% of salary or £60,000, whichever is lower. If they are not working they are restricted to £3,600 per year.
- •ISAs – you and your spouse have £20,000 each. If you or spouse are under 40 you can use a Lifetime ISA as part of this (or opened one before your 40thbirthday). You can contribute to LISAs up to the age of 50 and the government adds a 25% bonus on top.
- •General investment accounts – everyone has a dividend allowance of £1,000 (reducing to £500 from 6thApril) and a capital gains tax exemption of £6,000 (reducing to £3,000 from April 6th). You can build up a reasonable size GIA before being hit with a significant tax liability. Dividends and capital gains are both taxed at a lower (in capital gains’ case much lower) rate of tax than income tax.
- •You can hold taxable investments and cash in a spouse’s name if they are a lower rate tax-payer than you. This can be particularly powerful if they are a non-earner or basic rate tax-payer. There are other options which offer income tax relief but these are high risk investments and advice should be sought befoe considering them.
There are also further options for the next generation:
- •The Junior ISA allowance is £9,000 and operates much like an adult ISA. It will become an adult ISA at age 18 and the child will have full control over the investment.
- •You can contribute £3,600 to pensions for children. The drawback (or positive depending on your viewpoint!) is that they cannot access these until age 57, though will likely be later than this as the retirement age continues to be pushed back by government.
- •You can make gifts directly to children (or anyone) for example to help them buy a property. If you do this you will need to survive for 7 years for the gift to be outside of your estate for inheritance tax purposes and you have fully given up control. However, if you make gifts out of surplus income (simply your income minus your expenditure) this amount is immediately outside of your estate for inheritance tax purposes. You only have to do this regularly which to HMRC means more than once (i.e. once one year and once next year is probably OK).
- •You can also gift money into trust and the same inheritance tax rules apply as above. A trust means that you can remain a trustee and maintain control over the asset. There are 2 main types of trust – a bare trust treats the asset as though it was the child’s and they can access this when they turn 18 (they would have to take you to court but would win!). A discretionary trust allows you to maintain control and choose who and when is able to benefit from the assets. Our final point is to make sure you are on track for your own retirement before thinking about significant gifting, despite the tax advantages! You have worked hard to build and save for your own retirement so please make sure you are able to do all the things you have been saving for and dreaming of doing for many years.
