It has recently been reported over half a million taxpayers paid a marginal income tax rate of 60% in 2022/23, up by 23% from the number in 2021/22. This marginal rate applies where an individual’s adjusted net income falls between £100,000 and £125,140, where every £2 income over £100,000 reduces the £12,570 personal allowance by £1, such that it is fully eroded at £125,140.
Planning to mitigate the problem
The definition of “adjusted net income” is the individual’s total taxable income less personal pension payments and charitable payments under Gift Aid. Such payments can effectively save income tax at 60%. For example, an £80 payment to charity under gift aid is grossed up to £100 and the taxpayer’s income is reduced by £100, thus saving £60 tax where the individual’s income is between £100,000 and £125,140. If an individual’s total income is projected to be £105,000 for 2024/25 they could consider making an additional pension contribution of £4,000 before 5 April 2025 as that would reduce their income to £100,000, thereby restoring their £12,570 personal allowance.
Such planning is also effective for those caught by the high income child benefit claw back charge (HICBC). That charge claws back child benefit by 1% for every £200 adjusted net income between £60,000 and £80,000.
Salary sacrifice arrangements can also be effective
Another way to mitigate the effects of the personal allowance restriction and the HICBC would be to agree with your employer to forgo some of your salary, pay rise, or bonus for an additional employer pension contribution or an electric company car. For example, an employee on £96,000 a year might be entitled to a £10,000 bonus. They could agree with their employer to have £6,000 of the bonus paid into their pension (tax-free, provided the £60,000 pension annual allowance isn’t exceeded) with the remainder of the bonus just keeping them at £100,000 and retaining their personal allowance.
Sacrificing salary for an electric company car isn’t quite as tax efficient, as the employee would currently be taxed on 2% of the list price instead of the salary foregone. On a £50,000 electric car that would just be a £1,000 taxable benefit in kind, which for a 40% taxpayer would mean £400 income tax.
The employing company would obtain a tax deduction for the cost of providing the benefit and would also save on employers national insurance. So, it’s win, win.