What is the Personal Allowance?
The Personal Allowance is the amount you do not have to pay income tax on. This is currently £12,570 and will be frozen at this level until April 2026. As incomes rise, more people will pay tax, and more people will pay tax at the higher and additional rates. Your Personal Allowance may be higher if you claim Blind Person's Allowance or Marriage Allowance.
Your Personal Allowance is less if your income is over £100,000. Since 6th April 2010, the Personal Allowance is reduced by £1 for every £2 of adjusted net income above £100,000. When income is £125,140 or more, the Personal Allowance is zero.
The effective rate of tax for income between £100,000 and £125,140 is 60%. 20p of tax is added for every pound earned between £100,000 and £125,140, as tax becomes payable on previously tax-free income. This is on top of the higher rate tax of 40%. The resulting 60% tax rate is more than the additional rate of tax that those earning over £150,000 pay. It's also one of the highest marginal rates in Europe!
What can you do to reduce your exposure to the 60% tax rate and save up to £15,084 a year in tax?
✴️ You could consider making a pension contribution. The gross contribution reduces your adjusted net income. The combination of higher rate tax relief and the reinstatement of the Personal Allowance provides effective tax relief of 60%. Where salary exchange is used, you also save on National Insurance contributions. Your employer may also pass the savings they've made in reduced National Insurance on to you, by making a higher pension contribution.
✴️ You could consider making a Gift Aid donation, which will reduce your total income in a similar way to making a pension contribution.
✴️ Employees may be able to give up some of their taxable earnings for non-cash employee benefits of equivalent value. There are a wide range of benefits in kind that can be earned through salary sacrifice, which also saves on National Insurance. However, for benefits that count towards taxable earnings, such as private medical cover, there is no rebate of the Personal Allowance.
✴️ If your dividend income and savings income is putting your earnings over £100,000, you could consider transferring assets into your spouses or civil partners name, if they are a lower earner. However, you will be transferring the ownership of the asset to your spouse or civil partner. You can also ensure that you fully utilise your ISA (Individual Savings Account) allowance each tax year as dividend and savings income is tax-free within an ISA. The ISA allowance is £20,000 in the 2022-2023 tax year.
The options available to you to reduce your exposure to the 60% tax rate depends on your individual circumstances and your employer. The information in this post is based on my current understanding of the relevant legislation and regulations, which may change. Please note that this is guidance only and not personal advice. You should always seek appropriate advice before making decisions.
The information given relates to the tax year the article was written and tax and legislation may change in future years.