Use of VCTs to avoid 60% marginal rate

westy22

During 15/16 I am likely to exceed the £100,000 income band by about £15,000 due to a large bonus and the provision of a very nice company car. This is after the company has made the maximum contribution of £40,000 to my SIPP.

Would the use of VCTs help me to reduce my overall income below £100,000 to avoid the loss of personal allowance and the effective marginal rate of 60% on this £15,000?

I know that I receive 30% tax relief on VCT investment but cannot quite work out whether it reduces my income level in the same way that a pension contribution would.

TIA for any advice.

Spidernick

No, sorry - the VCT relief is a flat 30% and doesn't reduce your taxable income for the year.

Have you used the full annual pension allowance for any of the previous three years? If not, then you can use the remaining amount and still pay above the £40K limit for 15/16 and reduce your taxable income down to £100K that way (assuming your unused relief was a t least £15K).

Otherwise, is it really worth paying 60% tax on 'a very nice company car'? I know a lot of people set their stall by their car, but it's never something I've understood personally.

westy22

Thanks, spidernick. What you say is what I sort of expected.

Unfortunately (or fortunately) yes, my pension has been filled to the limit over the past 3 years so no scope for a carry forward contribution.

I did think long and hard about the company car, and it is CO2 efficient, but I am something of a sucker for high end cars so, if 60% is what I have to pay, then so be it.

I'm sure that many would love to be in my position so I am not really grumbling about the tax, just trying to MSE.

bowlhead99

While the 60% marginal rate feels really quite painful: I suppose one way to look at it is that your total compensation package from the company is £155k.

At that level of income, you don't get ANY of the annual £10k personal allowance, the last £5k of your pay and benefits gets taxed at 45%, and all future earnings (bank interest, bonuses etc) gets taxed at 45%. Effectively you're in the same tax position as anyone on a £500k or £1m salary.

So from there the optimal thing to do is to give up £40k and have it go into a SIPP, just like you've done. As a result, you saved 45% tax on £5k of income, and you saved 40% tax on another £35k of income, AND you got back some of your annual personal allowance which someone earning over about £121k doesn't get at all, but you on only £115k do get.

Getting the income down to a level where you get some of the personal allowance back means the pension contribution was really really useful because although we said you save £5k at 45% and £35k at 40% tax: on the last £6k of it (between 121 and 115) you also get 50p of personal allowance back for every £1 pension contribution, which saves you 20p of extra tax as a result of the pension contribution in that zone. So because you chose to make a pension contribution in that zone, you saved 40% tax AND 20% tax for a marginal 60% tax saving.

So, it's only natural that if the pension let you save 60% effective tax in one direction, if you earn new money from interest or bonuses or whatever, moving the income in the other direction, you'll pay 60% tax on those. Now you're out of pension allowance there is not a lot you can do.

As you suspected, a VCT contribution gives you a 30% kickback which isn't related to your marginal rate. Someone earning £30k with a marginal rate of 20% could still make a VCT contribution of £10k and get a £3k tax kickback, just like someone on £60k could or someone on £160k could, or someone like yourself on £115k could. The fact that it doesn't relate to your marginal rate, should not necessarily put you off - you have the advantage that you can perhaps spare the money more easily than someone earning £30k, so the opportunity shouldn't be ignored. It just doesn't get you out of your 'funny marginal rate' problem.

The only easy way to kill your 60% rate problem, now you've exhausted pension, is to give up your income, which isn't really a solution.

You could ask for some unpaid leave - you save your 60% tax and 2% NI so you're only giving up £38 net pay for each £100 you would have earned. Some employers let you do a 'salary sacrifice' for more holiday on even more lucrative terms. But you'll obviously still drop your net pay. For each £100 on the table you'll now get £0 instead of £38.

Similarly you could give up the car. But you'd get no car, instead of a car you paid 60% tax on.

You could make more contributions to charity. So for each £100 on the table from your employer, the charity would get £100, and you wouldn't pay 60% tax. Sounds great - but of course your take-home from the £100 would be £0 instead of £40.

So there's not much you can do with income you've already got, once you lose the ability to hide it in pensions. You should look for ways to avoid receiving it this year though. So if you have some cash on deposit with a bank, use an account that pays annually rather than monthly and aim for some of the interest to fall into the 16/17 year when you might have moved out of the awkward marginal zone. Or if you get a bonus at work that's going to be paid next March, ask if they can pay it next April instead when you might not be in that zone any more.

Also the other obvious things to do re savings and investments (other than VCT/EIS) are make sure you're making best use of your other allowances - ISAs for example are relatively more useful for those of us at high marginal rates than low ones. Aim to have your unwrapped investments, if any, produce capital gains instead of income. Obviously not really worth jiggling the investment strategies around for just one awkward year, but lower income and more growth is generally preferable when your underlying income levels are pushing beyond the £150k level.

Unfortunately growth companies and income paying companies and bonds can each perform differently in different parts of an economic cycle so it's very difficult to fiddle with them to meet an ultra-short-term tax objective, while still getting the best long term result.

Bottom line there's probably nothing clever you haven't already thought of. Little tax savings like cycle to work scheme (yes, even if you have a company car ), salary sacrifice for childcare vouchers etc can all help if they work for your circumstances. I think if you were contemplating VCT because you thought it would save 60% tax, doesn't mean you should now ignore it at 30% tax - it changes the breakeven quite a bit but if you can live without the money long term it is still a useful incentive.

kidmugsy

Spidernick wrote: »

I know a lot of people set their stall by their car, but it's never something I've understood personally.

It's because they don't have the nerve for cycling or motor-cycling.

bowlhead99

kidmugsy wrote: »

It's because they don't have the nerve for cycling or motor-cycling.

That's certainly the case with me

Cars don't give you quite the same thrill ride, but they get around corners in relative safety and get you to the destination without needing a change of clothes (or a change of underwear!). And if it doesn't go fast enough, and you have the cash, you can always get a bigger engine.

Paying 60% tax on a company car notional value seems a bit insane but if the alternative is taking a token amount of cash and still having to pay 60% tax on that, and you still want to drive a newish car, its maybe not a big deal.

Of course, the MSE way to do it is to take the cash and buy a 3-year old or 5-year old or 10-year old car for a rather lower percentage of the new price...

TheTracker

Is this likely to happen again next year? Just thinking out loud, but I think gut feel is the mathematically optimum solution is to only contribute 5k to pension, not 40, then next year contribute 75. You want to be caught out only every second or third year, not every year.

westy22

Thanks - some great advice there from all posters.

Particular thanks to bowlhead - comprehensive and well researched answer and advice, as always.

In all fairness, I get plenty of useful tax breaks in all sorts of areas so shame on me really for wanting my cake and ha'penny

Aretnap

TheTracker wrote: »

Is this likely to happen again next year? Just thinking out loud, but I think gut feel is the mathematically optimum solution is to only contribute 5k to pension, not 40, then next year contribute 75. You want to be caught out only every second or third year, not every year.

That's a good point assuming tax relief on pension contributions remains more or less constant. Personally I'd be worried that relief at the higher rates might not be around much longer, especially if Labour win the election, so I'd be tempted to make maximum use of it this year on the assumption that it might not be there next year.

TheTracker

Aretnap wrote: »

That's a good point assuming tax relief on pension contributions remains more or less constant. Personally I'd be worried that relief at the higher rates might not be around much longer, especially if Labour win the election, so I'd be tempted to make maximum use of it this year on the assumption that it might not be there next year.

I'm not convinced Labour would do that despite the 30k rumours. It was 200k+ from 2006/7 through 2010/11 under labour.

The OP could make a 25k contribution to reduce next years by 15 and avoid the 60% rate, or a 15k contribution with the concern around a 30k limit. I believe carry forward in the past has respected historical limits.

bowlhead99

I see the point you're making with the idea of a 5k pension this year and 75k the next - i.e., at least next year, the taxable pay is only 80k rather than 115k, so over the two years you do get to save one full nil-rate band.

It doesn't necessarily work out as good as that though. Firstly, the employer may not be so generous as to give £40k salary instead of a £40k SIPP contribution. That costs the employer a big chunk of NI, and the employee pays a couple of percent too. So, that lowers the marginal benefit for the current year, and the availability of a monster salary sacrifice in the next year to reverse the NI position will rely on the flexibility of the employer (which potentially will not be the same employer from year to year).

Also, in the second year, when you hope to get the basic salary down to well below £100k, this may not be possible. For example if he is on £155k now and gets a 10% payrise to £170k, and then perhaps a 10% bonus, even taking the 75k salary sacrifice that year he's still going to be up into the top end of the 'losing personal allowance zone' and on a 60% marginal rate.

So, there's something to be said for 'a bird in the hand'. Pushing yourself down into the 60% bracket for '15/16 gives you what seems like a 60% 'problem' but it is a function of claiming back some of your personal allowance. If you can do that this year, it is maybe better than doing a minimal pension contribution this year and not getting any personal allowance at all, while hoping you can get a better one next year.