The top rate of income tax is 45% – on paper at least! However, a quirk in the tax system means some high earners could be paying tax at an effective rate of 60%. The good news is that, with careful planning, it may be possible to minimise your exposure to the ‘hidden’ top rate.
The tax system explained
Many people will already know the basic tax bands:
■ a tax-free personal allowance (PA) of£11,500 for 2017/18
■ 20% on earnings between £11,501 and£45,000 (£43,000 for Scottish taxpayers)
■ a higher rate of 40% from there up to £150,000
■ an additional rate of 45% for earnings over £150,000
However, when you take into account the scaling back of the personal allowance – it is reduced by £1 for every £2 over £100,000 earned – there is a band in which earnings are effectively taxed at 60%. Between £100,000 and £123,000, at which point the PA is entirely depleted. This is because each £2 taxed at 40% exposes an additional £1 of PA to the lower rate of 20%.
Here are a couple potential strategies to mitigate this for the predicted 800,000 people that this affects.
Increase pension contributions Increasing pensions contributions can help to regain the PA by reducing adjusted net income to £100,000. In any case, tax relief on contributions could, effectively, be 60%.
Make Gift Aid donations
Making donations to a qualifying charity through Gift Aid can also reduce taxable income.