This month’s feature from Brand Financial Solutions, aimed at helping you with your exam study, looks at two tax charges that can catch people out, and how to mitigate against them.
Paraplanners are often the first to spot when a client is drifting into one of the UK’s more punitive and lesser-understood income tax traps. For higher earners, two thresholds in particular can have a major impact on take-home income:
- The Personal Allowance trap, starting at £100,000, where income tax rises sharply due to the tapering of the tax-free personal allowance.
- The High income child benefit charge, starting at £60,000, which claws back child benefit from families with higher earnings.
The good news is that both of the above share a common solution: pension contributions. Personal pension contributions reduce a client’s adjusted net income whilst helping to preserve allowances and generate effective tax relief as high as 60%.
These opportunities may not last. With the government hinting at reforms to pension tax relief, particularly for higher earners, there may be a limited window for strategic action.
The 60% tax band: Personal Allowance taper
The standard personal allowance is currently £12,570. But once a client’s adjusted net income exceeds £100,000, this allowance is reduced by £1 for every £2 earned above the threshold. When income reaches £125,140, the personal allowance is lost entirely.
The result is a 60% marginal tax rate on income between £100,000 and £125,140:
- 40% higher-rate tax on the income itself
- Plus 20% ‘hidden’ tax due to the loss of the tax-free allowance
It’s not visible on a payslip, but the impact is very real. This often affects professionals receiving pay rises or bonuses, who then question why their net income hasn’t increased as expected.
The hidden family tax : High income child benefit tax charge:
The High Income Child Benefit Charge affects families who claim child benefit where the highest earner in the household earns over £60,000. The benefit is reduced gradually when adjusted net income is between £60,000 and £80,000 and is completely lost when it reaches £80,000.
For a client with two children, that’s a loss of over £2,200 per year in child benefit – approximately an 11% reduction in income that’s already taxed at 40%.
The result is approximately a 51% marginal tax rate on income between £60,000 and £80,000:
- 40% higher-rate tax on the income itself
- Plus 11% ‘hidden’ tax due to the loss of the child benefit (for two children households).
Many families don’t realise they are affected until they are asked to repay the benefit via self-assessment.
Personal pension contributions: One smart solution
Personal (employee) pension contributions reduce adjusted net income, making them a powerful tool in both scenarios above.
Importantly, it is only employee contributions that reduce adjusted net income. Employer contributions do not.
Example 1: Reclaiming the Personal Allowance
- Emma earns £115,000
- She loses £7,500 of her personal allowance, costing her an extra £3,000 in tax
- She also pays 40% tax on the £15,000 over £100k = £6,000
- Total tax on the £15,000 of income over £100,000 is £9,000, or 60%
By making a £15,000 gross personal pension contribution, her adjusted income drops to £100,000. She regains the full allowance and saves £9,000 — achieving 60% effective tax relief.
Example 2: Avoiding the child benefit clawback
- Jack earns £68,000 and has two children
- By contributing £8,000 into his personal pension, his adjusted income drops to £60,000
- He avoids the charge entirely and retains £2,211 in child benefit
- Alongside 40% pension tax relief, this results in a very tax-efficient outcome
Tax-Efficient planning with long-term benefits
For many higher earners, pension contributions offer an efficient way to reclaim lost allowances, avoid benefit clawbacks, and build long-term retirement savings.
As it’s not possible to backdate pension contributions after the tax year-end, timing is crucial. Paraplanners should review income levels once clients are in a position to accurately forecast their salary, and they can then plan contributions before the tax year-end to maximise the effective tax relief. It’ll be too late when the clients reach the self-assessment stage!
About Brand Financial Training
Brand Financial Training provides a variety of immediately accessible free and paid learning resources to help candidates pass their CII exams. Their resource range ensures there is something that suits every style of learning including mock papers, calculation workbooks, videos, audio masterclasses, study notes and more. Visit Brand Financial Training at https://brandft.co.uk
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