High earners: how to avoid the loss of the personal allowance and save tax at 60%

by Tony Granger of www.taxinsider.co.uk

The personal allowance is a valuable benefit as it reduces your taxable income. However, if you earn in excess of £100,000, then the personal allowance reduces as follows:

If your adjusted net income is over £100,000, you lose £1 for every £2 above the limit. At £114,950 earnings you are left with no personal allowance.

As you are losing your personal allowance on income above £100,000, combined with a tax rate of 40 per cent, your effective rate of tax on earnings between £100,001 and £149,950 is 60 per cent.

There is plenty of motivation to reduce your net adjusted income to below £100,000 to retain your personal allowance, and reduce your tax burden.

The current personal allowances for 2012-13 are:

  • Basic personal allowance: £8,105
  • Age 65-74: £10,500
  • Age 75+: £10,660

Tax rates for 2012-13 are as follows:

  • Savings rates 10%: £0 - £2,710
  • Basic rate 20%: £0 - £34,370
  • Higher rate 40%: £34,371 - £150,000
  • Additional rate: 50% over £150,000

Strategy 1: If you are married or in a civil partnership

If you have a lower taxed or earnings spouse, then consider transferring income-producing assets to them. You could save your personal allowance and use theirs more effectively.

The transfer must be outright and unconditional, and there is no capital gains tax (CGT) or inheritance tax (IHT) if you are UK domiciled and living together.

If a 40 per cent taxpayer and you transfer the income-producing asset to a non-taxpaying spouse, you save 40 per cent on interest income and 22.5 per cent on dividend income.

Strategy 2: If you have investments

Redistribute investment capital so that you can reinvest in tax-free investments, or reinvest in tax-efficient investments that produce no income – such as unit trusts and Oeics for growth, or investment bonds. Either try to produce less taxable income or invest for growth.

Strategy 3: Reduce your taxable income through pension contributions

Making a pension contribution (you can make gross contributions of up to £50,000 per annum unless you use carry forward of unused allowances from the past three years, where the total contribution in the current year could be up to £200,000) can save your personal allowance and give you tax back.

The following example shows how this works.

Assume taxable earnings of £120,000 per annum. Male age under 65.

What are the savings in terms of tax should you make a lump sum pension contribution?

Lump sum contribution of £21,000 gross, net £16,800.

Brings taxable earnings to £99,000.

Saves personal allowance of £8,105 (so tax saved on this at £3,242 at 40 per cent, but increased to £4,863 as actually saves 60 per cent, which is the effective tax rate between £100,000 and £114,950).

HMRC also pays back 20% x £21,000 = £4,200, as you are a 40 per cent taxpayer making a pension contribution. In addition, HMRC uplifts your net contribution of £16,800 by £4,200, so that the gross contribution is £21,000.

Total savings in tax: £4,863 + 4,200 = £9,063 for a net pension contribution of £16,800.

This strategy has saved your personal allowance and reduced your tax payable.

Strategy 4: Make charitable donations

Similar to pension contributions above, making charitable donations (gift aid payments) is currently unlimited (although there are steps being made by the government to cap this).

Charitable donations reduce net adjusted income, therefore allowing you to save your personal allowance if you are reducing taxable income to below £100,000. Tax relief is claimed by the charity – the payment is treated as being paid ‘net’.

A higher rate taxpayer may claim additional relief against income tax or CGT (the income tax claim is for the difference between the higher rate and basic rate (40 - 20 = 20%) on the total value of the donation. If you donate £100, the total gift to the charity is £125 as a gross donation. You get tax relief back of 20% x £125 = £25.

Some additional tax tips are that:

  1. you can elect for the donation to apply to the previous tax year;
  2. you can gift shares, securities, land and buildings. These all reduce your taxable income.

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Published on: May 1, 2012

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