Effective income tax rate at 60%?

the_learner

Hello,

I recently got a promotion and, as a developer, my current base salary is £90,000.
On top of this I typically get a 10/15% bonus. This will be paid in March 2018.
So assuming a 15%, this would increase my taxable income for the 2017/18 fiscal year to £103,500.
Assuming a £11,500 personal allowance and 20% tax from £11,501 to £45,000 and 40% from £45,001 to £150,000, I calculated my tax bill as follows:

£11,500 at 0%
£39,499 at 20%
£58,501 at 40%

For a tax bill of £30,100 (about 29% tax).
Looking at the tax bands on the website I saw that if your income is above £100,000 your personal allowance will reduce by £1 for every £2 above the £100,000. In my case I estimate I will be above that threashold by £3,500 so my personal allowance will reduce to £9,750.
This means that my tax bill will be:

£9,750 at 0%
£39,499 at 20%
£60,251 at 40%

For a tax bill of £30,800 (29.76%). So I will pay £700 more taxes if compared to a situation where my personal allowance remains £11,500. This is a 20% increase to my marginal rate.
This means that for every additional £1,000 I get now, I will pay effectively 60% tax (62% if including NI), not only 40% (or 42% with NI).

Is my understanding correct? If so, that means that also on interets I get from my bank account I will have to pay 60% or that is treated differently? Thank you.

Dazed_and_confused

You are broadly correct, there is no actual 60% tax rate but in the band 100000-123000 (current tax year) there is a double whammy of 40% actual tax and loss of personal allowance which leads to the higher effective tax rate.

Interest isnt separated though, if you had £1000 interest then that is simply part of your income and the personal allowance would be reduced by another £500 with the interest being taxed £500 at 0% and £500 at 40%.

If you have a look on the pensions thread or some sipp provider websites you will find more info about this as pension contributions are seen as a tax effective way of mitigating this situation.

Googling adjusted net income will also be beneficial.

the_learner

Thanks a lot. So the idea would be to put £3,500 in a SIPP and that would bring my income back to £100,000?
If I do this, my net on £100,000 would be £71,300 while the net on the original £103,500 was £72,700.
Effectively, by placing £3,500 in a SIPP I get only £1,400 less on a net basis. Although I guess I should consider the fact that only 25% of that £3,500 can be taken tax free once I retire, right?

Dazed_and_confused

If you put money into a sipp it does not have any impact on your income, £103,500 is still £103,500 but for adjusted net income purposes you only have £100,000 so when your tax liability is calculated you have £103,500 income but still get the full personal allowance of £11500.

The sipp also extends the amount you pay basic rate tax on by £3500 so you pay less 40% tax as a result.

The sipp contributions of £3500 only actually costs you £2800 (the sipp provider gets the basic rate relief back direct from hmrc) so with the reduction in 40% tax paid the effective cost of having £3500 in your pension pot drops to £2100 and there is the additional benefit of getting your personal allowance back so the £3500 sat in your sipp has not cost all that much relatively speaking.

Any tax refunds come back to you, they aren't added to your sipp.

the_learner

Actually, I make a pension contribution already. It is 6% and my employer contributes another 6%. So to summarize, assuming a 15% bonus I would have £90,000*1.15=£103,500. But I am making a 6% contribution, so my total taxable woukd be £103,500*(1-6%)=£97,290.
Is this correct? If so, I wouldn't be over £100,000 for tax purposes so I would still have £11,500 personal allowance. I hope I interpreted correctly your suggestion.

Dazed_and_confused

Depends in part what type of pension you are already paying. Is it a sipp type with basic rate relief added at source or is it net pay where pension is deducted from salary then tax calculated after that?

the_learner

Dazed_and_confused wrote: »

Depends in part what type of pension you are already paying. Is it a sipp type with basic rate relief added at source or is it net pay where pension is deducted from salary then tax calculated after that?

Every month my employer keeps 6% from my pay and put that into a pension scheme. I am not aware of the technicalities but I guess it is a standard work pension scheme. Wondering if that 6% I contribute will reduce the taxable income at all...

Dazed_and_confused

Your payslip should show what's happened, for example
Pay £10000
Pension £600
Taxable pay £9400
Is net pay scheme

the_learner

Dazed_and_confused wrote: »

Your payslip should show what's happened, for example
Pay £10000
Pension £600
Taxable pay £9400
Is net pay scheme

In my payslip I have 2 sections. The pension contribution is reported in the top section only, as a negative number after the gross salary amount.

So I am not sure I have to consider this 6% as a factor reducing my overall taxable income when it comes to computing my personal allowance. Afer all, given the 6% contribution, if I sum up the gross salary on all my payslip (after pension deduction) I will not have £90,000 but 6% less. Same when I get the bonus pay.

Edit: I checked my arrangements and it looks like I pay pension contributions through salary sacrifice.

leosayer

the_learner wrote: »

Edit: I checked my arrangements and it looks like I pay pension contributions through salary sacrifice.

The most tax efficient way to pay into a pension is via salary sacrifice which will probably be into your employer's AVC.

It will probably save some NI if you pay #3,500 in one lump rather than spread over many months.

the_learner

Ok I got another question after reading few articles.
During the tax year 2016/17 I was paying taxes at a marginal rate of 40%.
My total pension contribution via the salary sacrifice scheme offered by my employer, is £5,000.
I read that my tax relief is 40%. The example goes like this: for a £10,000 contribution you only have to pay £8,000 and then claim an additional 20% back in your tax return.
What should I do then?
I usually do nothing since the money I put away is being sent to my pension pot by my company. Also I never did a tax return.
Do I understand correctly that I am entitled to get back cash for 20% of the £5,000 I contributed last year?