23/24 tax year
If you’re earning in excess of £100,000, then you’ll have considerable financial challenges, and the opportunities that arise may be more complex. In this guide, we reveal the expert’s approach to maximising your tax savings, avoiding the notorious 60% tax trap and how some methods can be applied to a specific financial goal.
- How to ensure you don’t miss out on tax relief by using your pension.
- How to overcome the dreaded 60% tax trap
- How to use your pension to pay off your mortgage – twice as fast
- Why protection matters if you’re a high earner
- How to choose the right financial adviser for you
Making the most of your pension
What if we told you that, as a high-earner, there is an investment which provides a 72% overnight risk-free return, simply by making use of your pension?
Any income earned by a higher-rate taxpayer over the £50,270 threshold, is taxed at 40% in Income tax and an additional 2% in National Insurance.
As an example, if your employer pays you £1,000, only £580 will arrive in your bank account after tax has been deducted – a disheartening reality.
There’s good news, though. Plan carefully, and you can pay less tax.
Most employers pay pension contributions via a method called salary sacrifice. This means that any pension contributions will be made gross of all tax, allowing you to claw back the 40% in Income tax and the 2% in National Insurance.
Using the same example, the £580 contributed to your pension will receive an immediate uplift of £420 in tax relief, which is a 72% return. Apply this to the maximum £60,000 annual contribution you can make to your pension (assuming you aren’t tapered) and you’d receive £34,800 in tax relief.
How to avoid the 60% tax trap
If you’re earning more than £100,000, you’ll find that a portion of your income is effectively taxed at 60%. This can be disheartening. You’re earning six-figures, yet your income is ravaged by taxation.
So how does the tax trap catch people out? First, let’s remind ourselves of the income tax rates for earnings if you live in England, Wales or Northern Ireland.
|Earnings||Income Tax Rate|
|£0 to £12,570||Personal allowance (no Income Tax payable)|
|£12,571 to £50,270||Basic rate: 20%|
|£50,271 to £125,140||Higher rate: 40%|
|Over £125,140||Additional rate: 45%|
When your taxable income reaches £100,000, your personal allowance is gradually cut by £1 for every £2 of income earned. Once your income reaches £125,140, you lose your tax-free personal allowance completely.
For example, if you’re awarded an additional £1,000 bonus, this is taxed at 40%. In addition, you’ll lose £500 from your tax-free personal allowance, meaning £500 more of your income will also be taxed at 40%, costing you a further £200.
Your £1,000 bonus has been taxed at an effective rate of 60% – the tax trap – which means you’ve paid £600 in tax, leaving you with just £400.
How to use your pension to get your money back
You can use your pension contributions to claim tax relief, reducing your taxable income and regaining your tax-free personal allowance.
Let’s assume you earned exactly £125,140 and have therefore lost your entire tax-free personal allowance. We’ll also assume you have a pension that you make net contributions to (i.e. not salary sacrifice), for ease of the example. If you make a pension contribution of £20,112, the government will apply £5,028 in basic-rate tax relief. They’ll pay this relief straight into your pension, taking your total pension contribution up to £25,140. A further £5,028 can be claimed in higher-rate relief on your tax return.
Your contribution will reduce your taxable income by £25,140, taking you back down to taxable earnings of £100,000. This means you’ll regain your £12,570 tax-free personal allowance, saving you yet another £5,028 in tax. That’s a total benefit of £15,084 – simply by putting your income into your pension.
|Before pension contribution||After pension contribution|
|Personal pension contribution||£0||£25,140 (£5,028 BR tax relief included)|
|Personal allowance||£0||£12,570 (£5,028 tax saving)|
|Higher rate relief claimed||£0||£5,028|
*40% of the taxable income £25,140 = £10,056 40% of the personal allowance £12,570 = £5,028
The savings don’t stop here either as, in practice, National Insurance can also be saved on your pension contributions if your employer facilitates salary sacrifice.
How to pay off your mortgage twice as fast
The 60% tax trap can have a considerable impact, but by planning carefully, you could even pay off your mortgage almost twice as fast
Let’s consider if you want to pay off £250,000 of your mortgage, by making over-payments of £1,000 each month, or £12,000 a year. For the purpose of the example, we’ll assume you’re earning exactly £129,358.62. Here’s how much income will be required to make a £12,000 over-payment on the mortgage:
|£29,358.62||Income tax (higher rate)||40%||£11,743.448|
|£12,570||Loss of personal allowance/ additional income tax||40% (60% effective rate)||£5,028|
|Total tax paid on £30,000:|
Net Income Remaining:
Your £12,000 annual mortgage payment will require almost £30,000 in income. Paying off £250,000 of your mortgage with overpayments will take almost 21 years and require more than £600,000 of gross income!
Using you pension to pay off your mortgage faster…
If, instead, you contributed the same £29,358.62 a year to a salary sacrifice pension, this will be gross of all tax. Not only would you avoid the 60% tax trap, but when you are able to access your pension, you can take 25% of it tax-free. Depending on the size of the pension pot, you can take a maximum of £268,275 free of tax – more than enough to pay the £250,000 mortgage in full.
By using your pension, you’ll:
- pay off £250,000 of your mortgage in just over eight-and-a-half years – 13 years faster than overpayments.
- shave a further one-and-a-half years off this timeline when investment growth is added.
- save over £360,000 in tax!
If you’re a high earner and are considering making pension contributions instead of making overpayments on your mortgage, ‘when’ you plan to retire and your specific mortgage arrangements have an impact so it’s worth seeking advice.
Why protection matters
You wouldn’t fail to take out home or car insurance but when it comes to our most important asset, the majority of us don’t protect it at all.
If you’re earning around £100,000 a year, you’ll be generating over £8 million in lifetime earnings, if we assume your earnings increase in line with rough historic inflation levels. You are undoubtedly the most Important asset you have.
The Institute and Faculty of Actuaries carry out a continuous study into mortality and illness across the UK, which provides a rich source of information to draw conclusions from. When you consider the data from their study, it should act as a significant reality check.
Ensuring you have the right level of life insurance, income protection and critical illness in place for your circumstances is just as important as putting enough money in your pension.
Consider whether your workplace ‘death in service’ policy is enough to cover both your mortgage and the earnings that would have contributed to the household. In addition, corporate income protection will often only cover a portion of your net income, usually 50-60%. So, how would you fund your pension if you were to get sick?
As a high earner, it’s vital to consider your financial objectives and what risks could knock them off track.
How do you find the right financial adviser for you?
If you’re a high-earner, or have £250,000 or more to invest, you need to ask if a behemoth bank will provide the personal service you need. Their size often means they are slow to innovate and many are failing to keep-up when it comes to service levels. It’s worth looking for a financial adviser that will provide a bespoke service that suits your individual needs.
As consumers, we are used to having everything in one place. If you’re interested in simplicity and convenience, it’s worth asking potential advisers whether they:
- Have their own platform
- Provide in-house pensions and tax wrappers
- Are able to arrange insurance for you, alongside financial planning and investment management.
Having an all-in-one solution will remove potential hassle and headache.
Independence is also a key element when attempting to find the right financial adviser for you. Some restricted firms only offer their own in-house investment offering, as they believe the way they look after money is superior. This is understandable, as it’s ultimately a unique selling point for an investment firm, and having direct oversight of the investment strategy can be an important part of meeting a client’s objectives.
However, in-house solutions might not always be the best option for a particular individual. Clients have varying needs, which is why it is important for your adviser to have multiple investment options when necessary.
Ideally, you want to find the best of both worlds. An independent firm that has an in-house investment offering with a proven track record is preferable. However, they should also have the ability to select outside of their core offering, if you need an alternative solution to meet your requirements.
It is also unlikely any single individual will be an expert financial planner and a high-quality investment manager. Ideally, you should choose a firm that has separate financial planning and investment management teams, with specialists in both fields.
Try not to simply look for the cheapest or, indeed, the most expensive option. When finding a financial adviser ask the question: “can you demonstrate to me how you have added value for your fees?”
The most expensive, active management can be very good value if it has genuinely added consistent outperformance. Similarly, the cheapest passive solution starts to become very expensive, if it has performed poorly for the amount of risk it’s taking. Therefore, don’t just look at the price, look at value.
Overall, finding the right financial adviser can be challenging, particularly for higher earners. Take the time to find the right partner for you.
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All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.
Saltus Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.
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