During the autumn statement, the new chancellor announced a raft of changes and freezes to tax thresholds and allowances.
You’ve already read why Inheritance Tax freezes could be a stealth tax on wealth, and a freeze on personal Income Tax thresholds could also result in you paying more tax in the coming years.
Indeed, thanks to a quirk in the taxation system, the Telegraph reports that 2 million people could face paying an eye-watering 60% tax on a portion of their income in the years to come.
Read about the Income Tax changes Jeremy Hunt announced in the autumn statement, and why you could end up paying 60% Income Tax.
Tax thresholds frozen until 2028, and the additional-rate threshold reduced
In the autumn statement, the chancellor froze two key Income Tax thresholds until 2028.
- The Personal Allowance – the amount you can usually earn before you start paying Income Tax – will remain at £12,570.
- The threshold at which you start to pay higher-rate tax (40%) will remain at £50,270.
As earnings increase over the next few years, it’s likely that you’ll pay more tax on your income than you would have if these thresholds had been uprated in line with inflation.
In addition, Jeremy Hunt announced plans to reduce the threshold for paying the additional rate of Income Tax (45%) from £150,000 to £125,140 as of April 2023.
Anyone who earns more than £150,000 will therefore pay just over £1,200 more tax in 2023/24.
If you earn over £100,000 you could pay 60% tax on some earnings
As earnings increase, more and more people are likely to earn more than £100,000 in the coming years.
According to research in the Telegraph, around 1.3 million taxpayers earned over £100,000 in the last tax year, up from 1 million in the year before. By 2028, the year the freeze on tax thresholds is due to end, the research estimates that a total of 2 million workers will earn at least £100,000.
So why is earning more than £100,000 an issue for taxpayers?
It’s because of a quirk in the tax system that reduces your Personal Allowance if you earn more than £100,000.
At this point, you lose the benefit of your Personal Allowance at a rate of £1 for every £2 of income. If you earn more than £125,140, you lose your Personal Allowance altogether.
What this means is that, on earnings between £100,000 and £125,140, you are taxed at an effective rate of 60%.
If you also consider the fact that you’ll likely pay National Insurance contributions (NICs) of 2% on these earnings, only £38 of every £100 you earn between £100,000 and £125,140 ends up in your pocket.
A simple way you can avoid this 60% tax trap
One method you can use to avoid paying 60% Income Tax on this part of your income is to consider paying more into your pension. This reduces the earnings that fall into this bracket.
Here’s an example.
Suppose you receive a £1,000 pay rise, which takes your taxable income from £100,000 to £101,000. If you take it as salary, you’ll pay 40% (£400) in Income Tax, and your Personal Allowance will reduce by £500 – meaning you’ll pay an additional 40% tax on these earnings (£200).
Instead, if you pay that £1,000 into your pension, you won’t enter the 60% tax bracket. In addition, you’ll usually get the benefit of a 40% top-up on your contribution, thanks to tax relief. Depending on your scheme, that £1,000 may also be boosted further with additional employer contributions.
Remember that, in 2022/23, you can pay a maximum of £40,000 into your pension each year (or 100% of earnings if lower) and still enjoy tax relief on your contributions.
Get in touch
If you have any questions about how the autumn statement could affect you, or how you can use pension contributions to reduce tax, please get in touch.
Contact us by email at firstname.lastname@example.org or call us on 01189 876655.
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The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
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This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.