When you move up the career ladder, it isn’t just your own finances that benefit.
Once you hit the higher-rate Income Tax bracket, the taxman takes a much bigger chunk of your money. Without careful planning, you could end up paying far more tax than you need to.
From maximising your allowances to planning your pension withdrawals, here are five tax-saving tips for higher earners.
1. Maximise your ISA and pension allowances
A straightforward way of reducing how much tax you pay is to invest in an ISA. In the 2020/21 tax year, you can put £20,000 into ISAs and shield your money from Income Tax, Dividend Tax and Capital Gains Tax. For a higher earner, this can result in significant tax savings.
Investments held outside an ISA attract tax at the following rates:
- Income Tax of up to 40%, or 45% if you’re an additional-rate taxpayer
- Capital Gains Tax of 20% on profits above your £12,300 annual allowance
- Dividend Tax of 32.5% on dividends above your £2,000 allowance, or 38.1% if you’re an additional-rate taxpayer.
Another way of shielding your money from tax is to invest in a pension. Each time you pay into your pension you receive 20% tax relief from the government. Higher-rate and additional-rate taxpayers can claim a further 20% and 25%, respectively. So, for a higher-rate taxpayer, a £1,000 pension contribution effectively costs you £600.
The maximum amount you can pay into a pension each year and receive tax relief is 100% of your salary, up to an Annual Allowance of £40,000.
If your ‘adjusted income’ is above £240,000, your Annual Allowance will reduce to a minimum of £4,000. Some steps to consider include carrying forward unused Annual Allowances from previous tax years and paying into your spouse’s pension.
Bear in mind pension money can’t be accessed until you reach age 55 – or age 57 from 2028. In contrast, you can withdraw money from ISAs whenever you like, which may make them more suitable for shorter-term goals.
2. Use your spouse’s allowances
ISA and pension allowances are per individual, which means couples effectively have a £40,000 ISA allowance and an £80,000 pension Annual Allowance.
To make the most of your tax reliefs and allowances, you could consider transferring assets between you and your spouse. Some of the potential benefits include:
- Maximising both of your ISA and pension allowances
- Taking advantage of one partner’s higher rate of pension tax relief
- Reducing the amount of tax payable when you withdraw income in retirement
- Doubling up your annual Capital Gains Tax allowance.
Transfers between spouses can be made tax-free and are a legitimate way of reducing your overall tax bill as a family unit.
3. Plan how you withdraw money in retirement
Income in retirement doesn’t have to come from pensions. In fact, it’s often more tax-efficient to withdraw money from other sources of income first.
When it comes to your pension, you can withdraw up to 25% tax-free and the rest is taxed at your marginal Income Tax rate. ISA withdrawals are tax-free, so it may be wise to deplete your ISAs before your pensions in retirement.
It’s also worth bearing in mind that ISAs form part of your estate when calculating your Inheritance Tax bill. Pensions aren’t usually part of your taxable estate, making them a tax-efficient way of passing wealth to future generations.
4. Consider salary sacrifice
Another way of potentially reducing your overall tax bill is to join your employer’s salary sacrifice scheme. This enables you to give up part of your salary in return for benefits like increased pension contributions or childcare vouchers.
Salary sacrifice reduces your income, which means you pay less Income Tax and National Insurance.
There are some potential drawbacks to be aware of, such as reduced borrowing on mortgages, and reduced entitlement to state benefits and maternity pay.
5. Invest for your children or grandchildren
If you’ve used up your ISA allowance, you could consider investing in a Junior ISA on behalf of your children or grandchildren. Junior ISAs have the same tax advantages as adult ISAs, and your child can’t access the money until they turn 18. You can invest up to £9,000 per child in the 2020/21 tax year.
You could even start investing into a pension for your child. You can contribute up to £2,880 per child and the government will add 20% tax relief, boosting the amount to a maximum of £3,600 in 2020/21.
Get in touch
If you’re a higher earner and would like advice on structuring your investments and pensions, please get in touch. Email email@example.com or call 01904 655330.
The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation which is subject to change.