The 60% Tax Trap
In the 2008 Pre-Budget Report on 24th November 2008, the Chancellor announced the proposed implementation of a tapering of the personal allowance for those individuals with income in excess of £100,000. On the 22nd April 2009, Chancellor Alastair Darling delivered his 2009 Budget, which contain revisions of the Pre Budget proposals. It is, therefore, appropriate to revisit this issue.
Currently, tapering of personal allowances only exists where individuals are aged 65 and above. The higher personal allowance of £9,470 for those between 65 and 74 and £9,640 for clients aged 75 and above is reduced by £1 for every £2 of income over and above £22,900 per annum. Where an individual is caught by this, a review of income planning in retirement is highly recommended as this may identify solutions to alleviate the effect.
With effect from 6th April 2010, an additional potential tapering is set to be introduced. It is proposed that where an individual enjoys an income in excess of £100,000, that individual’s personal allowance will be reduced by £1 for every £2 of income. This simplified approach replaces the previously proposed 2-tier approach. Therefore, based upon an assumed personal allowance of £6,800 for 2010/2011, anybody below the age of 65 with income in excess of £113,600 will see their personal allowance reduce to zero.
Based upon the previous proposals, it was believed that there appeared to be few planning opportunities to avoid the tapering of allowances, as the definition of income for this purpose is total income before any reductions. This has now changed and personal contributions to personal pension plans or Gift Aid contributions have an effect of reducing an individual’s income.
Example
Pre Pension Contribution |
Post Pension Contribution | ||
| Income | £113,600 | Income | £113,600 |
| Pension Contribution | Nil | Pension Contribution | £13,600 |
| Reduced Income | £113,600 | Reduced Income | £100,000 |
Limit |
£100,000 |
Limit |
£100,000 |
Excess |
£13,600 |
Excess |
Nil |
Personal allowance reduced by |
£6,800 |
Personal allowance reduced by |
Nil |
Tax assessable income |
£113,600 |
Tax assessable income |
£93,200 |
Assessable income reduced by |
Nil |
Assessable income reduced by |
£20,400 |
40% tax saving |
Nil |
40% tax saving |
£8,160 |
In this example, the assessable income has reduced by £20,400. Assuming the income is paid as salary, this will reduce the Income Tax liability by 40%, equating to £8,160, which is effective pension contribution relief of 60% on a pension contribution of £13,600.
Clients that have their own limited companies are able to exert control over their income each year and indeed the structure of that income between salary and dividends. Simple planning such as considering employer contributions into pensions rather than salary in the above example would yield additional savings in the form of National Insurance, both employee and employer. Key employees may also be able to negotiate with their employer to take advantage of this by way of ‘salary sacrifice’.
We should add that also contained within the 2009 Budget were measures to restrict higher rate tax relief on pension contributions for those with taxable income of £150,000 or more. Whilst this is to be formally implemented with effect from 6th April 2011, complex anti-forestalling measures have been implemented to avoid such individuals advancing pension contributions in the interim. This came into effect 22nd April 2009. Where any clients are considering such planning in this area, it is highly recommended that they seek professional, independent financial advice. More information on this subject is to be published shortly, however, note in the interim that ‘salary sacrifice’ does not work in reducing salary for this purpose.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Should you have any queries or wish to discuss any of the points raised, please contact Peter Edwards on 0161 477 6789.
Date of Article: 29th May 2009
