Date posted: 24th Jun 2019
If you have income of more than £100,000, then you could be paying some of your tax at a rate of 60%.
I can’t see the 60% tax rate listed anywhere?
Whilst the 60% tax rate is not an official tax rate, there is an effective rate of 60%.
This is the combined effect of the application of the higher rate of tax and the reduction in the personal allowance, where income exceeds £100,000. The personal allowance is set at £12,500 for 2019/20.
Once income exceeds £100,000 the allowance is gradually reduced by £1 for every £2 of ‘adjusted net income’ over £100,000.
Once the ‘adjusted net income’ exceeds £125,000, the personal allowance is eliminated in full.
What is ‘adjusted net income’?
This is an individual’s total taxable income before personal allowances and after deducting certain reliefs, such as:
- relief for trading losses;
- donations to charity through the Gift Aid scheme (deduct the grossed-up amount of the donation); and
- pension contributions (deduct the gross amount).
Sally has a salary of £100,000 for 2019/20 with no other sources of income and no tax reliefs to claim. However, she received a bonus of £20,000 from her employer.
Her income is therefore £20,000 over the £100,000 threshold which means that her personal allowance is reduced by £1 for every £2 of ‘adjusted net income’ over £100,000 i.e. reduced by £10,000. Her personal allowance entitlement for the year is therefore £2,500 (£12,500 – £10,000).
The PAYE tax calculated at source (which would have been based on her being allowed a full personal allowance of £12,500) purely on her salary would have been:
Total income – £100,000
Less: personal allowance – £12,500
Taxable income – £87,500
£37,500 x 20% = £7,500
£50,000 x 40% = £20,000
Total – £27,500
As a result of receiving the bonus of £20,000, which reduces the personal allowance to £2,500, her tax liability becomes:
Total income – £120,000
Less: personal allowance – £2,500
Taxable income – £117,500
£37,500 x 20% = £7,500
£80,000 x 40% = £32,000
Total – £39,500
So as a result of receiving a £20,000 bonus, Sally’s tax liability has increased by £12,000 i.e. 60% of £20,000.
Action to take?
To reduce the income falling in the abatement zone (taxed at a marginal rate of 60%) and to preserve as much as the personal allowance as possible, it is necessary to reduce adjusted net income.
There are various ways in which this can be achieved.
The first point to consider is the timing of income – can income be deferred to the next tax year, or, if income for the current tax year is less than £100,000 but is expected to be above £100,000 in the following year, can income be brought forward to the current tax year. In a family company scenario, it may be possible to achieve this by adjusting the timing of dividends and bonuses.
Consideration could also be given to putting income earning assets into the name of a spouse or civil partner to reduce income and preserve the allowance.
Adjusted net income is income after pension contributions. Making pension contributions is tax effective, both in terms of benefitting from the relief available and reducing net income to preserve personal allowances.
Alternatively, a person can make charitable donations under gift aid to reduce their adjusted net income. Although they will lose the benefit of their income, the cost will be offset slightly by the preserved personal allowance, and their chosen charity will be benefit from the donation plus the associated gift aid.
As above, Sally has taxable income for 2019/20 of £120,000 – £100,000 salary and a £20,000 bonus.
She makes a personal pension contribution of £8,000 using her bonus, which HMRC ‘top up’ to £10,000.
Her adjusted net income for 2019/20 becomes is £110,000 (£120,000 – £10,000).
As her income is more than £100,000, her personal allowance is still reduced. However, it is only reduced by £5,000 now. It therefore becomes £7,500 and her tax liability becomes:
Total income – £110,000
Less: personal allowance – £7,500
Taxable income – £102,500
£37,500 x 20% = £7,500
£65,000 x 40% = £26,000
Total – £33,500
Her tax liability has decreased by £6,000 as a result of a pension contribution of £8,000 in cash terms.
This is a significant saving and it must be remembered that the cash in the pension can then be invested and hopefully grow with tax free returns. The pension could be accessed once Sally turns 55 and she could potentially extract 25% as a tax free lump sum and the remainder as a pension, at possibly a lower rate of tax than 40%. Of course, financial advice should be taken before any pension contributions are made, particularly in light of various recent changes regarding the amount that can be saved tax efficiently in a pension.