Psychology of accepting higher rate tax

YellowStarling

Not sure if this is better suited at a different board, but I'll start here and welcome guidance on redirecting it if so.

Re PAYE employment, I'm interested to learn if I'm in a minority when it comes to struggling to 'accept' paying income tax at the higher (or even additional) rates, plus more in NI contributions, in return for a higher take-home amount that can be used to increase the amount I already save, the amount I already use for enjoyment (disposable) or or the amount I already invest (outside of pension/relief at source).  And/or whether are ways to think about it that make it easier.

Let me explain:

I earn above the basic income tax rate.  I am also fortunate enough to be able to utilise a salary sacrifice approach to my DC pension.  Currently, I am using AVCs via salary sacrifice to reduce my pre-tax salary to a point where I am only paying tax at the BR.  Of course, I also then benefit from lowering my NI contributions (plus I receive 50% of my employer's NI saving as a further top-up to my pension).

I am not quite at the pension annual allowance - if I was then (ignoring any previous years' unspent allowances for ease) it would make my decision for me.

The quandary

But I am beginning to wonder if I am skewing myself too much towards my retirement and not doing enough for my present situation in terms of savings (I have emergency savings), net tax investments (I have S&S ISA, LISA, some smaller non-wrapped holdings that I contribute to) or even enjoyment (upping my disposable income or the amounts I donate to charities), though this is lower in my priorities and consider myself to be fortunate enough to enjoy a decent quality of life and am comfortable that I donate a fair bit to charitable causes.

From various reading/resources, I consider my pension pot to be quite a bit above the average for my age, despite my natural caution with relying on averages when I am not sure if the average person is actually doing enough for retirement.  Similarly, despite that same caution factoring into my forecasting/modelling, I do not expect to be found seriously wanting in terms of final pension value for the quality of life that I'd like to have, the age I'd realistically like to retire and even when modelling for the fairly long life I'd hope to have!

In other words then, much of the reason for my current pension contribution is being driven by my desire to optimise my tax 'burden' (and even this is purely about numbers, as I do not have an objection to paying more tax in principle given where it supposedly goes), even though I would like to skew my overall wealth back towards my present self (savings, investments) a little more.

TL;DR
Do others struggle with the decision to forgo AVCs that are under the annual pension allowance, pay the income and NI tax on this income, in return for using the residual towards non-pension items?  If so, are there tips to think about this in a different way from:  focusing on optimising your tax position whilst knowing that the income forgone is making its way to your future self anyway?

Jeremy535897

The answer to your question will depend on a number of factors you do not mention, including your age, your dependents and their ages, your health, the security of your employment, whether there are two earners in your household, the value of your pension pot, your desired retirement age, whether you own a home, your attitude to risk etc etc.

molerat

plus more in NI contributions,

 ??

As a higher rate tax payer you generally start paying less in NI,  2% instead of 12% so your deductions only jump from 32% to 42%. Unless in Scotland where you are stiffed with higher tax and miss out on the lower NI on the first £7K.

YellowStarling

Jeremy535897 said:

The answer to your question will depend on a number of factors you do not mention, including your age, your dependents and their ages, your health, the security of your employment, whether there are two earners in your household, the value of your pension pot, your desired retirement age, whether you own a home, your attitude to risk etc etc.

A fair point - I guess I was referring to a situation where I'm inherently comfortable with all of those things, in other words I don't need the additional income that I am otherwise locking away for retirement, but if I wanted the income now (to make it work for my present self vs future self), how do I weigh that up against knowing I'm not optimising my tax position.

But perhaps your question has helped get nearer to my answer:  that the acceptance of lowering my AVCs to fundamentally increase my takehome pay, albeit incurring more tax than is optimal in doing so, is made easier when factoring the reason behind doing it: i.e. deciding between needing more to meet my needs (that my family and dependents and immediate liabilities are catered for) or needing more to meet my wants, and - if lucky to be down to just wants rather than needs - weighing up whether I value saving on tax more than being able to have more net pay to do with as I please (based on investment goals, attitudes to risk, the other factors that you've outlined).

Thanks for your reply all the same!

YellowStarling

molerat said:

plus more in NI contributions,

 ??

As a higher rate tax payer you generally start paying less in NI,  2% instead of 12% so your deductions only jump from 32% to 42%. Unless in Scotland where you are stiffed with higher tax and miss out on the lower NI on the first £7K.

Maybe my poor phrasing - I was referring to is the fact that I would technically be forgoing NI savings, and generally paying more NI on my post-deductions salary in absolute terms (not brackets), by reducing my AVCs.

theoretica

It is an interesting one - because no one likes paying tax, but actually I value (some) of the things tax pays for very much and consider them worth paying towards.

Will you be a higher tax payer in retirement?  Have inheritance tax due on your estate?  How much are you avoiding tax and how much just postponing it?

Exodi

YellowStarling said:

molerat said:

plus more in NI contributions,

 ??

As a higher rate tax payer you generally start paying less in NI,  2% instead of 12% so your deductions only jump from 32% to 42%. Unless in Scotland where you are stiffed with higher tax and miss out on the lower NI on the first £7K.

Maybe my poor phrasing - I was referring to is the fact that I would technically be forgoing NI savings, and generally paying more NI on my post-deductions salary in absolute terms (not brackets), by reducing my AVCs.

I think you've missed molerats points (about NI reducing at the higher tax rate)... below £50,270 you're paying 20% income tax and 13.25% NI (soon to be 12%) NI = effectively taxed at 33.25%. Above £50,270 you're paying 40% income tax and 3.25% NI (soon to be 2%) = effectively taxed at 43.25%. He was pointing out that moving from basic rate to higher rate isn't a 20% increase in overall taxation (as some may quickly assume), it's actually only a 10% increase because your NI goes down at the same time.

Unless you are referring to employer NI, as I understand you're currently sharing this. So each £1k paid through PAYE would attract £150.50 of employer NI (which I understand you split, £75.25 each). This doesn't reduce as you move into the higher tax rate - but this justification also applies from about £9k earnings per year, yet no-one would consider it reasonable to try and reduce their salary to maximise this.

Ultimately, you've got to strike a balance (I am in the same situation as you, I can change my SS arrangement at whim).

These forums promote money saving, but life is for living and spending 2/3rds of your life (your best years) 'getting by' doesn't make much sense to me.

Grumpy_chap

Lot's of personal considerations in assessing the OP's question and it is only those personal considerations that make a decision possible.

I would certainly weigh up whether the higher rate tax is avoided now only to be suffered at retirement.

Also consider the extent to which the current income is permanent or influenced by temporary factors.  There could be many but one would be HICBIC.  It may make sense to make higher pension contributions for the final couple of years of child benefit entitlement and then drop pension contribution down - but that is a purely tax assessment and is still not taking into account whether the household really needs that income now.

Simes122

How old are you?

I'm in Scotland, so get hit by the marginal 54.25% Tax NI rate between 43662 and 50k.   I see that as unfair differential taxation - I'm paid via a UK National pay spine, but get clobbered by more tax than my colleagues on the same pay point on the pay spine who aren't in Scotland.    Thus I sal sac to the max to avoid paying too much tax and as I'm retiring soon, it all fits my strategy.    However, I'm now in the last year, and I can no longer sal sac to the max for the whole year or I exceed Annual Allowance.   Thus I wrestle with the same thing - it pains me to only get 45.75p of every £1 I earn once I've filled my Annual Allowance.   

I'm well off for sure, but it still grates when I see how much of my gross salary I need to take to make less than half the difference in my pay packet.  It is what it is in a sense, and if I needed more net income now, I'd take it.   But I'm of a mindset this close to my retirement, I'd rather enjoy it then, than now and be comfortable then.    There are precious few options short of working again once retired, to improve your income.   And tax is useful, but noone really wants to pay more than they have to, unless they were especially altruistic!   You can volunteer to pay more tax apparently - I bet there aren't many that do!!!

I've always worked on the basis that actually, I want to achieve the same level of expenditure in retirement as I do when I'm working (obviously tempered by some slight reduction in expenditure made up for increases elsewhere - more hols/travel eg).   I don't want to live well when I'm working but poorly when retired.   The opposite is true probably!   So you need to choose, based on your age, whether or not your current pension strategy is the right one, or are you happy to sacrifice income in your retirement years etc.  That should inform how much you should be saving now, and spending now, vs in future.

Albermarle

OP - There is a limit on how large a pension pot can get, before tax penalties start to be incurred- The Lifetime Allowance.

It is a complicated subject and the rules may well change before you get there, especially as the penalties tend to have to be paid later in life, rather than in your 50's or 60's. However if it looks like your pot could easily exceed a Million Pounds, with the current level of contributions + some small growth, then it maybe wise to cut back pension contributions in favour of saving from taxed income for the shorter/medium term.
The caveat is that 40% tax relief may not be available for ever, so maybe better to maximise it now while you can.

YellowStarling

Exodi said:

YellowStarling said:

molerat said:

plus more in NI contributions,

 ??

As a higher rate tax payer you generally start paying less in NI,  2% instead of 12% so your deductions only jump from 32% to 42%. Unless in Scotland where you are stiffed with higher tax and miss out on the lower NI on the first £7K.

Maybe my poor phrasing - I was referring to is the fact that I would technically be forgoing NI savings, and generally paying more NI on my post-deductions salary in absolute terms (not brackets), by reducing my AVCs.

I think you've missed molerats points (about NI reducing at the higher tax rate)... below £50,270 you're paying 20% income tax and 13.25% NI (soon to be 12%) NI = effectively taxed at 33.25%. Above £50,270 you're paying 40% income tax and 3.25% NI (soon to be 2%) = effectively taxed at 43.25%. He was pointing out that moving from basic rate to higher rate isn't a 20% increase in overall taxation (as some may quickly assume), it's actually only a 10% increase because your NI goes down at the same time.

Unless you are referring to employer NI, as I understand you're currently sharing this. So each £1k paid through PAYE would attract £150.50 of employer NI (which I understand you split, £75.25 each). This doesn't reduce as you move into the higher tax rate - but this justification also applies from about £9k earnings per year, yet no-one would consider it reasonable to try and reduce their salary to maximise this.

Ultimately, you've got to strike a balance (I am in the same situation as you, I can change my SS arrangement at whim).

These forums promote money saving, but life is for living and spending 2/3rds of your life (your best years) 'getting by' doesn't make much sense to me.

Yes, I was referring to the absolute terms of paying more income and NI tax if I opt to receive more salary net of deductions such as pensions AVCs.  I accept I hadn't spelt out the fact that the higher rate of income tax-applicable income attracts a lower rate of NI and softening the jump, but I was referring to the fact that my AVCs can help me avoid 2% NI (and more tax in absolute terms) altogether.  And, yes, then the fact that reducing my AVCs technically reduces my 50% share of my employer's NI savings too.

Your final point is a healthy (within reason) and therefore helpful one, and one that will probably assist me a great deal in my decision.