Best way to reduce ridiculous marginal tax rate?

knuckledragger

A query for a (lucky) friend-
Their salary is about to increase substantially to about £115K. How can they best tackle the crazy marginal tax rate that is created between £100K and £115K?

marlot

Pension contributions. They're allowed to put in up to £50k/year

bowlhead99

In that awkward band for a while after 100k you pay your 40p per pound, and you lose 50p of personal allowance per pound, and pay your 40% on that, being another 20p on top of the 40p. So yes it's a 60% rate on everything until you've entirely given up your personal allowance and then some normality returns on future pay rises/bonuses.

You're probably in the right sub-forum as pension is the easiest answer. Presuming the pension contributions this year and the last couple have been well under the maximum allowable - there will be 'space' to take the earnings between 100k and 115k and contribute it to a pension plan; it will effectively all be tax free this year, and you only pay tax on it when you turn it into a pension distribution at retirement (or on turning 55). If it's not going directly from your salary to a company personal pension plan, where the company just takes it off you at source, you'l have to do a tax return after the end of the year to get a cheque back from HMRC for the tax suffered.

One thing to note is that if the salary is only just now rising to 115k from something lower, it's not been 115k all 2012/13 tax year and so there probably isn't a full 15k being taxed at this crazy rate. E.g. first half of year earn half of 75k, second half of year earn half of 115k; only 95k in total for year. So might not be quite as much money, if any, getting locked away into the pension as feared, this first year.

If an extra voluntary pension pot is being created, it might be an opportunity to create a SIPP or other new personal pension rather than just throwing it into the existing one - might be the kickstart needed to actually look at what retirement funds already exists and evaluate them, which many people don't do.

Of course there are other alternatives than just sucking up the tax, but for example charitable donations get 'relief' but obviously don't actually leave you with any more net worth than if you had paid the tax. Just happier charities.

Obviously once you've neatly reduced total gross pay for the year back to the less outrageous 40% bracket, you might get a year-end bonus that puts you into the 60% range again, and have to re-plan by 5 April.

Some would say this is a pretty nice 'problem' to have, but I agree with comment "crazy marginal rate". Clearly if the employer wants to spend an extra 1k on the employee while in this bracket, it's going to cost the employer a chunk of e'rs NI, the employee some ee's NI, and 60% tax: less than 340 quid taken home.

Your friend might find there are other solutions from their HR department which help a bit, as flexible benefit schemes abound. Maybe take more holiday in lieu of pay, some bike-to-work tax-efficient thing, get paid in childcare vouchers or something.

Final comment, while it seems a no-brainer to avoid 60% tax now with the assumption of paying 20% or so in retirement, we can't actually tell what this person's income will be in retirement, or what rates will be set by the governments of the day, and your pal might value a house deposit or rainy-day fund NOW, rather than lower tax leakage to get something potentially larger in 20 years.

thenudeone

The gradual removal of child benefit for those earning £50k - £60k also means that every £ earned results in well over 50p in tax + loss of chid benefit. so someone earning £50k pays a a higher incremental rate of tax than someone earning £20m.

It makes pension contributions even more attractive as a means of preparing for retirement, when every £1 saved costs less than 50p.

knuckledragger

Thanks for the replies. By the end of the tax year he might just scrape under the £100K bar, assuming his bonus isn't too large- oh for the chance to worry about such issues!
Given the above information he will certainly have to start organising additional pension contributions come April 2013.

bowlhead99

I agree, although to obtain the tax relief on a contribution in the 2013/14 tax year he simply has to have an account ready to accept contributions by the time he gets to the first few days of April 2014; HMRC don't care whether he puts it into the wrapper on 6 April 2013 or 5 April 2014, and once it's in it can't come back out.

somethingcorporate

Does he have the opportunity to contribute to any sharesave / direct share schemes?

As far as I am aware these bring down the taxable burden by being purchased out of gross salary but need to be left untouched for 3/5 years before they can be taken without the need to pay tax.

gadgetmind

somethingcorporate wrote: »

As far as I am aware these bring down the taxable burden by being purchased out of gross salary

Share save (SAYE) definitely comes out of fully-taxed income, but I don't know about SIPs as we don't have such things.

Pensions are the way for the OP to go, particularly if salary sacrifice is available, but it works OK even without this. If putting lump sums into a SIPP or similar, you do have to call HMRC and tell them. If they ask you to estimate your salary for the year (as anything over £100k affects tax code) tell them £99,999.99

ermine

SIP is from pre-tax but the limit is very low, about £125 pcm ISTR, so yes it's worth doing but is only good for sheltering £1500 p.a.

You do, of course, take the risk of the shares going down, and on the upside get the divi payments from the off. Shares have to stay in the SIP account for five years to be tax free. The risk of the shares going down is of course softened by the 40% (or 60% here?) tax you didn't pay that you'd otherwise have lost.

gadgetmind

SIPs can also be transferred directly to both ISAs and (confusingly!) SIPPs without a disposal for capital gains purposes.