Navigating ‘tax traps’ in the UK – a guide for high earners (II)
- TBA
- Nov 8, 2024
- 3 min read
Updated: Feb 25
In our previous reports, we shared that over 500,000 UK taxpayers have fallen into the 60% tax trap, an increase of nearly a quarter from last year due to the impact of frozen thresholds. As inflation continues to push up wages, the number of people caught in the high-income tax trap has surged significantly over the past year.
Bowmore Financial Planning has warned that the new government should take urgent action to address this inequality, as it could deter people from striving to increase their income above £100,000 per year. Bowmore’s CEO Mark Incledon stated, ‘As the rising cost of living erodes the real value of wage growth, the new government must address the problem’.
This will only undermine people’s motivation to work harder, increase productivity, and ultimately drive economic growth.” — now let’s explore some strategies you might consider to help avoid it!
1. Utilising Personal Pensions
When HM Revenue and Customs (HMRC) calculates your taxable income, only your adjusted net income is considered. This means that personal pension contributions have a direct impact on the final taxable amount, which could, in turn, help reduce your overall net income.
For example, consider Mr Z, who has an annual income of £125,000. He decides to contribute £20,000 to his personal pension scheme. Under current regulations, personal pension contributions are eligible for 20% basic rate income tax relief, and higher-rate taxpayers can benefit from an additional 20%.
Consequently, Mr Z can ultimately gain 40% tax relief, effectively increasing his pension contribution to £30,000. As a result, his adjusted net income reduces to £95,000, allowing him to retain his personal allowance while simultaneously enhancing his pension pot.
At the same time, based on the performance of your pension fund, you may benefit from potentially higher returns, and in the long term, your interest can earn additional interest.
2. Non-Cash Bonuses
For those employed in industries such as investment banking or sales consulting, requesting non-cash bonuses from your employer can be an effective approach. These bonuses could include benefits such as private medical insurance, a company car, or childcare provisions.
By opting for these non-cash perks, you can potentially reduce your basic taxable income to below £100,000 while still enjoying additional ‘perks’ provided by your employer.
Alternatively, you could donate to charity to cut your income to under £100,000 and get tax relief.
3. Tax-Free Savings
When developing a financial plan, you must avoid being too hasty. While the interest rate on deposit accounts is certainly important—the higher the rate, the more you could potentially earn—we recommend also taking your situation into account. This will determine whether you have a tax-free allowance.
If a portion of your annual income is derived from savings interest, opening an Individual Savings Account (ISA) could be a prudent choice.
Individuals currently have an annual ISA allowance of £20,000 per financial year, and the income earned within an ISA account is completely tax-free.
By taking advantage of this allowance, you can maximise your savings and reduce the impact of taxable income from interest. After doing this, you could then consider opening other types of deposit accounts.
4.Investing in Start-Ups
Another valuable strategy involves exploring the UK government’s Seed Enterprise Investment Scheme (SEIS). This scheme encourages investments in qualifying start-up companies and offers up to 50% income tax relief to investors. The plan requires that businesses must have been established for less than two years and have fewer than 25 employees.
For instance, if you invest £10,000 in a qualifying start-up, your income tax bill could be reduced by £5,000. While this can be an attractive measure, it is essential to consider the risks involved in start-up investments and assess whether it aligns with your financial goals and risk tolerance.
While these strategies offer promising opportunities, the UK system is complex, and various aspects must be carefully managed.
Therefore, we highly recommend consulting an advisor for tailored advice and meticulous planning to navigate these options effectively.
If you have further questions or would like more information, please feel free to reach out to us for additional guidance!