Guide to tax issues for high earners
Most people in full time employment have relatively simple tax affairs and their employment income is taken care of via PAYE without them needing to submit a self assessment tax return. This is not the case for high earners, earning above £100,000, or for families claiming child benefit where at least one family member is earning over £50,000.
If you're in this situation then Government legislation may mean you start to lose benefits that you were otherwise entitled to. This can have significant tax implications, in some cases meaning you're paying 62% of your income in tax and national insurance contributions or mean you are being taxed twice on your pension contributions.
This guide is intended to make sure higher earners are aware of the pitfalls. We'll describe tax planning opportuntunities that can be used to help avoid or minimise these issues as well as benefit your overall tax planning strategy.
Tax pitfalls for higher earners
If you're earning over £100,000 it is mandatory to submit a self assessment tax return, even if your only income has already been taxed under PAYE. You should be contacted by HMRC to inform you of this and substantial penalties apply for failing to submit your returns (even if no extra tax is due).
Adjusted Net Income
Your adjusted net income is the amount that's relevant to most of the additional tax charges and restrictions in tax relief that you face as a high earner. Your adjusted net income is your total taxable income, before any Personal Allowance, but after certain tax reliefs:
- Trading losses, if you are self employed or in a partnership.
- Donations made to charities through Gift Aid
- Pension contributions
Loss of personal allowance
Most taxpayers are entitled to a personal allowance, currently £11,850, and pay no tax on this income. However, those with an Adjusted Net Income above £100,000 start to lose thier personal allowance. Your allowance is reduced by £1 for every £2 you earn above £100,000. Those earning above £123,700 have no personal allowance.
This means that for earnings between £100,000 and £123,700 you are paying Income Tax at an effective rate of 60%. Combined with National Insurance Contributions you only take home 38p in every £1 you earn between these limits.
Loss of child benefit
If you or your partner receive child benefit and either of you earns above £50,000 you suffer additional tax to claim back some or all of the benefit you received. The additional tax is calculated based on the amount that your "adjusted net income" exceeds £50,000. The difference is divided by 10,000 and multiplied by the actual benefit you received.
If either of you earns £60,000 the full amount of benefit you've received will be reclaimed, and it's simpler to make an election not to receive child benefit.
Tapering of annual pension contribution allowance
Most individuals are entitled to significant tax benefits on contributions of up to £40,000 per year into their pension(s). However these tax benefits are restricted if your adjusted income is over £150,000 and your threshold income is over £110,000. If this applies, your annual pension contribution allowance is reduced by £1 for every £2 of taxable income exceeding £150,000 subject to a minimum allowance of £10,000 (which applies to those earning above £210,000).
Adjusted Income and Threshold Income both include all of your taxable income, so isn't just restricted to employment earning - it also includes investment income, savings income and benefits in kind such as medical insurance premiums. Adjusted Income also includes all pension contributions during the year (including any employer contributions) whereas Threshold Income excludes all pension contributions (including any you've made, or amounts given up via salary sacrifice arrangements).
There are further adjustments (as for Adjusted Net Income above) and anti-avoidance measures. It's possible to alleviate the impact, at least for the first few years, by carrying forward unusued annual allowances from the last three years. If you're likely to be impacted by tapering of your annual pension allowance then we'd recommend you get professional advice from an accountant.
If you exceed your annual allowance you pay tax at your marginal rate (likely to be 45%) as well as being taxed on pension income in retirement. For many people it's better to avoid exceeding your annual allowance by reducing personal contributions. Often your employment contract entitles you to employer contributions based on your basic salary and these may exceed your annual allowance after tapering. Avoiding breaching your annual allowance may not be possible unless you can renegotiate with your employer to switch the excess pension contributions for salary or other benefits.
Tax planning opportunities
Most people can contribute up to £40,000 per year into their pensions. Pension contributions are a highly tax efficient form of investment in general. Their benefit is even greater for higher earners because they reduce your Adjusted Net Income so can save you tax at up to 60%. If you make contributions via salary sacrifice you will also avoid National Insurance Contributions, increasing your potential savings to 62%. Salary sacrifice savings schemes also save your employers from their National Insurance Contributions and some employers pass this saving onto you - in which case your total saving increases to over 75%.
Note that you do pay income tax on your pension income during retirement, so strictly the savings to Income Tax are a deferral of tax. However most people will pay tax at a signficiantly lower rate in retirement. Note also that your annual limit is restricted for very high earners (as above) and that a lifetime limit of £1m applies to the total value of your pension (including any gains on investment).
Other salary sacrifice arrangements
The benefits of salary sacrifice aren't limited to pension contributions. Some (but not all) salary sacrifice arrangements you make with your employer are also effective at saving you Income Tax and National Insurance:
- Childcare vouchers (subject to restrictions on the amount you can benefit from on childcare vouchers, and the phasing out of this benefit).
- Cycle to work schemes.
- Ultra-low emission vehicles including company cars.
- Retraining courses and outplacement services.
- Buying additional annual leave.
These may be saving you tax at up to 62% depending on your marginal rate of Income Tax.
Charitable donations made under Gift Aid have tax advantages for the organisation receiving the donation, who can claim a 20% uplift in your donation (the effect being to also pass to them the basic rate tax you've paid on that income). Higher and additional rate taxpayers can claim an additional tax relief from their Income Tax. Of particular relevant to this guide is the fact that such donations are deducted from your income when calculating your Adjusted Net Income. This means they may be saving you further tax, at up to 60%.
Making tax efficient investments
Although, with the exception of pension contributions, these won't help alleviate any of the tax pitfalls for higher earners, making use of tax efficient investments is still an important part of tax planning for high earners. See our free guide to tax efficient investments for more details.