There are four thresholds affecting higher rate taxpayers that have fallen significantly behind wage inflation – the higher rate threshold for income tax is one of them. Higher rate income taxpayers are up 2.65 million since the threshold was frozen in 2021/2022.
Wages have risen 29% since this threshold was frozen, but other less well-known thresholds have been even more affected. Helen Morrissey, head of retirement analysis, Hargreaves Lansdown tells us more.
A pay rise is always welcome, but over the past few years it has come with a horrible sting in the tail for millions of people, pushing them over the threshold into paying higher rate tax.
And while paying more tax on a chunk of their salary is bad enough, there are also several other sneaky traps lying in wait for higher earners when they cross a threshold.
When first starting to pay 40% income tax, it automatically bumps up the rate paid in other taxes, from savings to dividend tax. It halves the personal savings allowance too, so tax is paid on more of savings, at a higher rate. Then when earning a bit more, well before getting anywhere near the additional rate tax threshold – other horrible tax traps bite.
The tax attacks
Income tax on earnings: You’ll be aware that the higher rate tax threshold has been frozen at £50,270 from April 2021 to April 2031, and the income tax rate will rise from 20% to 40% once you cross the threshold.
You might not know that wages have risen 29% since the freeze, so if the threshold had kept pace with wage inflation it would be £64,848.
Losing the personal allowance: Once earnings reach £100,000, the personal allowance is cut by £1 for every £2 of adjusted net income* above this level, until the allowance is zero once earnings reach £125,140.
This is an effective tax rate of 60%. This threshold hasn’t moved since it was introduced in April 2010. Over that time, wages have risen 68%, so to keep pace with wages it would have had to rise to £168,000.
High-income child benefit charge: The high-income child benefit charge kicks in at £60,000. If income (or a partner’s income) has pushed over the threshold, and in receipt of child benefit, a need to repay at least some of it through self-assessment arises.
The charge was introduced in January 2013 at £50,000, so has risen less than wages, which are up 53% in that time. To keep pace, the lower threshold would have had to rise to £80,000. Once earning £80,000, there’s a requirement to repay it all.
However, if not working, claiming child benefit means qualification for National Insurance credits, which count towards state pension. So it’s best not to cancel the benefit or avoid claiming it entirely, claim the benefit but waive the payments.
Loss of state help with childcare: This includes tax-free childcare, which is worth up to £2,000 a year and is available until earnings reach £100,000, at which point parents no longer qualify. This threshold hasn’t moved since April 2017.
Over that time wages are up 48%. It also includes the free childcare hours for younger children. The cost of this loss will depend on how many children there are and how much the childcare costs amount to, but it can suddenly add thousands of pounds to outgoings.
Attacks on savings and investments
Dividend tax: There’s a higher rate of tax on dividends if changing tax brackets. Basic rate taxpayers pay tax at 8.75% and higher rate taxpayers 33.75%. This increased in April 2022 and is set to rise again this April to 10.75% and 35.75%.
The tax-free allowance has also fallen from £5,000 in 2017/18 to £500 in the current tax year, pushing more people into paying this tax.
Capital Gains Tax: There’s a higher rate of CGT after crossing the threshold, and since October 2024, the rate for gains on stocks and shares has risen to 18% for basic rate taxpayers and 24% for higher rate taxpayers.
In the current tax year, gains can be made of £3,000 before paying tax, down from £12,300 in 2022/23.
Tax on savings: Savings can be subject to income tax, so if there’s tax to pay it’ll be at a higher rate. From 2027, savings will actually attract a higher rate of income tax than other forms of income, so basic rate taxpayers pay 22%, higher rate taxpayers 42% and additional rate taxpayers 47%.
IN addition, there’s a smaller personal savings allowance. Basic rate taxpayers can make £1,000 of interest before worrying about tax, but for higher rate taxpayers this falls to £500 and £0 for additional rate payers. The personal savings allowance hasn’t risen since it was introduced in April 2016.
7 end-of-tax year strategies to cut your tax bill
1. Pay into a pension: Higher rate taxpayers benefit from tax relief at their highest marginal rate. Contributions can be made up to £60,000 into a pension this tax year and carry forward unused allowances from the previous three tax years.
2. Escape the high-income child benefit charge: The benefit of paying into a pension doesn’t necessarily stop there. It also reduces adjusted net income*. If a parent is earning between £60,000 and £80,000, cutting back towards £60,000 means they can reduce their high-income child benefit charge.
3. Use pensions to deal with the £100,000 threshold: If earning over £100,000, there will be a loss to some of the personal allowance. Use a pension to reduce income, and it will cut the amount of tax paid at an eye-watering 60%.
So, for example, if income is £101,000 and a contribution of £1,000 is paid into a pension, £400 tax relief is received, but it also takes income to the £100,000 threshold, so the personal allowance doesn’t tape, saving another £200 in tax.
It means that £1,000 contribution has effectively cost just £400. Plus, if a parent can bring their income back under £100,000, they may keep their eligibility to tax-free childcare too.
4. Make use of capital gains tax allowance: If there are investments outside an ISA, it’s worth considering taking advantage of the CGT allowance every tax year. Use the Bed and ISA process (also known as share exchange) to move these assets into an ISA.
Don’t forget, you can offset any capital losses made during the tax year against gains. If total taxable gain is still over the tax-free allowance, it is possible to deduct any unused losses from previous tax years.
If just some of the losses reduce the gain to below the tax-free allowance, the remaining losses can be carried forward to a future tax year.
5. Shelter as much income-paying assets in ISAs as possible: If using the Bed and ISA process to shelter income-producing investments in a stocks and shares ISA, there’s no tax on dividends in future.
Because the rate at which dividend tax is paid, is often higher than the rate at which capital gains tax is paid, it’s often worth prioritising this when making decisions about how to use the ISA allowance.
Meanwhile, a cash ISA can protect savings interest from tax.
6. Plan as a couple: If married or in a civil partnership and a partner pays a lower rate of tax, transferring income-producing assets into their name is beneficial. It means it is possible to take advantage of both tax allowances.
Don’t forget to use all the tax-efficient vehicles at disposal, including ISAs and pensions, as well as the Junior ISAs and Junior SIPPs of any qualifying children.
7. Consider a Venture Capital Trust: These aren’t right for everyone, because they are higher risk, so should only ever be considered as a small part of a large and diverse portfolio.
However, if using these schemes, in addition to the CGT and dividend tax saving, you can get up to 30% income tax relief on the amount invested, which can reduce the overall tax bill.
*Net adjustable income is total taxable income before any personal allowances and less certain tax reliefs, including: trading losses, donations made to charities through gift aid, pension contributions paid gross (before tax relief), and pension contributions where provider has already given tax relief at the basic rate.
It’s complicated, but the key here is you can cut your net adjustable income by making pension contributions.
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